A unique, authoritative, and comprehensive treatment of fixed income markets
Fixed Income Trading and Risk Management: The Complete Guide delivers a comprehensive and innovative exposition of fixed income markets. Written by European Central Bank portfolio manager Alexander During, this book takes a practical view of how several different national fixed income markets operate in detail.
The book presents common theoretical models but adds a lot of information on the actually observed behavior of real markets. You’ll benefit from the book’s:
- Fulsome overview of money, credit, and monetary policy
- Description of cash instruments, inflation-linked debt, and credit claims
- Analysis of derivative instruments, standard trading strategies, and data analysis
- In-depth focus on risk management in fixed income markets
Perfect for new and junior staff in financial institutions working in sales and trading, risk management, back office operations, and portfolio management positions, Fixed Income Trading and Risk Management also belongs on the bookshelves of research analysts and postgraduate students in finance, economics, or MBA programs.
Table of Contents
Foreword xv
Part One Preliminaries
Chapter 1 Introduction 3
Chapter 2 Money, Credit and Banking 9
2.1 Abstract properties of money 9
2.2 Early forms of money 11
2.2.1 Paper money and bank notes 14
2.3 Fiat money 15
2.3.1 Fiat money and trade 15
Chapter 3 Banks 17
3.1 Banks and bank money creation 17
3.2 Categories of banks 18
Chapter 4 Bank Money Creation 20
4.1 Single-bank introduction 20
4.2 Extension to multiple banks 22
4.3 Transfer settlement in central bank money 25
4.4 Trade and non-bank credit 28
4.4.1 Non-cash trading instruments 29
4.4.2 Discounting 30
4.4.3 Delineating payment instruments from money 30
4.5 Digital token monies and cryptocurrencies 31
4.6 The money multiplier 32
Chapter 5 The Role of Central Banks 34
5.1 Introduction 34
5.2 Monetary financing 39
Chapter 6 Monetary Policy 40
6.1 Objectives of monetary policy 40
6.2 Monetary policy under inflation targeting 43
6.3 Central bank operational frameworks 46
6.3.1 Symmetric interest rate corridors 47
6.3.2 Asymmetric lending corridors 49
Chapter 7 Operational Frameworks 50
7.1 Control of the money supply 50
7.2 Liquidity provision: Rediscounting, outright purchases and Lombard lending 51
7.3 Liquidity absorption: Asset sales and reverse repos 52
7.4 The impact of FX operations 52
Chapter 8 Interaction between Frameworks and Policy 54
8.1 Volatility 54
8.2 Collateral 55
Chapter 9 Non-Standard Monetary Policy 57
9.1 Quantitative easing 57
9.1.1 The Monetary Effect of Large-Scale Asset Purchases 61
9.1.2 Market liquidity and central bank asset purchases 62
9.1.3 Helicopter money 63
9.1.4 Choice of methods and assets 65
9.2 Practical experience 67
9.2.1 QE, money multipliers and FX 67
9.2.2 Bank of Japan 2013 QE experience 71
9.2.3 Lessons from the initial BoJ quantitative easing 72
9.3 Negative interest rates 73
9.4 The specific situation of the ECB 74
Part Two Cash Instruments
Chapter 10 Contract and Instrument Types 79
10.1 Securities and bilateral contracts 79
10.2 Security identifiers 81
10.2.1 ISIN codes 81
10.2.2 CUSIP codes 83
Chapter 11 Trading and Settlement 85
11.1 Trading 85
11.1.1 Trading and price formation 85
11.1.2 Trading venues 86
11.1.3 The OTC trade lifecycle 87
The trade inquiry 89
Negotiation 89
Agreement 90
Recording 91
Enrichment 92
Reporting 92
Pre-confirmation 93
Allocation 93
Confirmation 94
Settlement instructions 94
Fails 95
Reconciliation 96
11.1.4 The exchange trade cycle 96
11.1.5 Trading in competition versus single dealer inquiries and orders 97
Mistrades 98
11.2 Settlement 98
11.2.1 Settlement mechanisms 99
11.2.2 Settlement conventions 99
Chapter 12 Central Clearing 101
12.1 Direct clearing 101
12.2 Indirect clearing 106
12.2.1 Agency clearing 106
12.2.2 Principal clearing 107
12.2.3 Hybrid clearing models 107
12.3 Contract value adjustments (xVA) 108
12.3.1 Credit Value Adjustment 108
12.3.2 Funding Value Adjustment 109
12.3.3 Debit Value Adjustment 110
Chapter 13 The Money Market 111
13.1 Money market instruments 111
13.2 Discount factors 112
13.3 Daycount conventions 114
13.4 Money market interest rates 115
13.5 Compounding 116
13.6 LIBOR, Euribor, and friends 117
13.7 Overnight benchmarks 119
13.8 Benchmark reform 120
13.9 Money market futures and futures trading 121
13.9.1 Money market futures 121
13.9.2 Identification of futures contracts 122
13.9.3 Futures trading basics 124
13.9.4 Convexity adjustment 124
Chapter 14 The Repo Market 126
14.1 The repurchase market 126
14.2 Haircut 128
14.3 Variations of repurchase transactions 128
14.4 Rehypothecation 130
Chapter 15 Spot and Forward Rates 131
15.1 Forward rates 131
15.2 No-arbitrage calculations 131
15.3 Official rates versus term rates 133
15.3.1 The turn premium 133
15.3.2 Matching policy expectations to market rates 134
Chapter 16 The Bond Market 137
16.1 Introduction 137
16.2 Cashflow types 138
16.2.1 Bullet bonds 138
16.2.2 Zero coupon bonds, perpetuals and annuities 139
16.3 Issuer types 142
16.3.1 Joint issuance 144
16.3.2 Supranationals 146
16.4 Governing law and contractual clauses 147
16.5 Bond markets 151
16.5.1 The primary market 153
16.5.2 The secondary market I: (interdealer market) 157
16.5.3 The secondary market II: (customer-facing market) 158
16.6 Accrued interest 158
16.7 Yield 159
16.7.1 Running yield 160
16.7.2 Simple yield 160
16.7.3 Compound yield 160
16.7.4 Bond-equivalent yield 161
16.8 Interest rate risk 163
16.9 Convexity 164
16.10 Bond value decomposition 165
16.11 Carry 167
Chapter 17 Floating-Rate Notes 169
17.1 Coupon reset mechanics 170
17.2 Libor and OIS-linked notes 171
17.3 Discount margin 173
17.4 CMS and CMT floaters 174
Chapter 18 Asset Markets and Liquidity 176
18.1 Concepts 176
18.2 Liquidity measurement 180
18.2.1 Taxonomy of liquidity measures 181
18.3 Examples 183
18.4 Liquidity premium 185
18.5 Liquidity and volatility 187
Chapter 19 Curves and Curve Models 189
19.1 Models 190
19.2 Yield curve representation and interpretations 191
19.2.1 Discount factors versus par curves 191
19.3 Market-based curve representations 193
19.3.1 Bootstrapping 193
19.3.2 Reverse bootstrapping 195
19.4 Parametric curve models 196
19.4.1 The Nelson-Siegel and Nelson-Siegel-Svensson splines 197
19.4.2 Polynomial splines 198
19.4.3 The exponential spline 199
19.4.4 The Vasicek spline 200
19.4.5 Composite models 202
19.5 Fitting curve models 203
Chapter 20 Curve Analysis 205
20.1 Expectations 205
20.2 Convexity bias 209
20.3 Term risk premium 211
20.4 Preferred habitat 212
20.4.1 Asset-liability matching 212
20.4.2 Regulatory constraints 213
20.4.3 Passive investing 214
20.4.4 Central bank reserve portfolios 215
20.4.5 Market technicals 215
Chapter 21 Carry and Roll-Down 217
Chapter 22 Curve Spreads 220
22.1 Z-spread 220
22.2 Par spread 221
22.3 Swap spreads 222
22.3.1 Asset swap spreads 222
22.3.2 I-spreads 223
22.3.3 The TED spread 224
Part Three Inflation-Linked Debt
Chapter 23 Inflation-Indexed Bonds 227
23.1 Introduction 227
23.1.1 Cashflows of inflation-linked bonds 230
23.1.2 Quotation of index-linked bonds 232
23.2 Rebalancing, rebasing and revision of CPI indices 232
23.3 Inflation seasonality 234
23.4 Price formation in inflation-linked markets 238
23.5 Return measures of inflation-linked bonds 240
23.6 Breakeven inflation 241
23.7 Carry on inflation-indexed bonds 244
23.8 Comprehensive inflation modelling 245
23.9 Inflation models and expectations 249
Part Four Defaultable Claims
Chapter 24 Credit Risk 255
24.1 Default, insolvency, and bankruptcy 255
24.2 Seniority and subordination 256
24.2.1 Time subordination and acceleration 256
24.2.2 Contractual subordination 256
24.2.3 Statutory subordination 257
24.2.4 Joint liabilities and credit support 258
24.2.5 Sovereign debt 259
24.3 The default process 259
24.3.1 Collective action clauses 261
24.3.2 Debt exchanges and consent solicitations 262
24.3.3 Managed defaults 263
24.3.4 Wind-downs 263
24.4 Credit ratings 264
24.4.1 Rating migration 266
24.4.2 Alternative rating approaches 270
Chapter 25 Covered Bonds 272
25.1 Statutory covered bonds 277
25.2 Danish covered bonds 279
25.3 Structured covered bonds 281
25.4 Covered bond credit risk analysis 282
Chapter 26 Asset-Backed Securities 284
26.1 The ABS issuance process 285
26.2 Default risk of ABS 286
26.3 Maturity of ABS 287
Chapter 27 Residential Mortgage-Backed Securities 289
27.1 Residential mortgage prepayments 290
27.2 Prepayment modelling 292
Part Five Derivatives
Chapter 28 Bond Futures 301
28.1 Introduction 301
28.2 Futures trading patterns 303
28.2.1 Open interest and trading volume 303
28.2.2 CFTC data for US futures contracts 307
28.3 Valuation of physically delivered bond futures 310
28.3.1 Basis and implied repo rate 310
28.3.2 Conversion factors and the notional coupon 312
28.3.3 The cash-and-carry arbitrage 314
28.3.4 The quality option 315
28.3.5 Hedging with futures 316
28.4 Futures rolls 321
28.4.1 Roll ratios 324
28.4.2 Advanced futures delivery models 325
28.5 Delivery windows 326
28.6 Interaction between futures and bonds 327
28.7 Futures squeezes 329
28.8 Cash-settled futures 331
28.8.1 Exchange-for-physical transactions 332
28.9 New bond issues 332
Chapter 29 Swaps 334
29.1 Introduction 334
29.2 Plain vanilla swaps 336
29.3 Trade compression and re-couponing 338
Part Six Standard Trading Strategies
Chapter 30 Trading Principles 343
30.1 Definitions 343
30.2 Trade identification 345
30.3 Trade portfolios 346
Chapter 31 Curve Trading 347
31.1 Simple curve trades 350
31.1.1 Outright Trades 350
31.1.2 Steepeners and Flatteners 350
31.1.3 Butterflies 353
31.1.4 Condors 354
31.2 Intrinsic curve movements 354
31.2.1 Alternative specifications 360
Chapter 32 Bond Trading 362
32.1 Bond relative value 362
32.2 Relative value strategies 363
32.2.1 Spread widener/tightener 363
32.2.2 Basis trade 364
32.2.3 Bond spread 365
32.2.4 Bond spread with curve hedge 365
32.2.5 Alternative strategies 366
Part Seven Risk Management
Chapter 33 Principal Component Analysis 371
33.1 PCA as generalised regression 373
33.2 Measuring data complexity with PCA 375
Chapter 34 Bond Index Mechanics 378
34.1 Bond index principles 378
34.2 Index rebalancing 380
Chapter 35 Portfolio Risk Management 381
35.1 Risk-neutral portfolios 381
35.2 Index tracking 383
35.2.1 Factor analysis and spanning sets 385
35.2.2 Friction effects 387
Chapter 36 Hedging 389
36.1 Introduction 389
36.2 Duration-neutral hedges 390
36.3 Regression hedges 391
36.4 Yield curve model hedges 392
Chapter 37 Mean-Variance Optimisation 395
Chapter 38 Portfolio Rebalancing 403
38.1 Passive and semi-passive strategies 404
38.1.1 No reallocation 404
38.1.2 Passive management 404
38.1.3 Index replication 405
38.1.4 Constant asset allocation 405
38.1.5 Trend-Following 406
38.1.6 Mean reversion 406
38.2 Numerical examples 407
Part Eight References
Chapter 39 Selected Global Bond Markets 413
39.1 Euro area 413
39.1.1 Austria 414
39.1.2 Belgium 415
39.1.3 Finland 416
39.1.4 France 416
39.1.5 Germany 418
39.1.6 Greece 421
39.1.7 Ireland 422
39.1.8 Italy 423
39.1.9 The Netherlands 424
39.1.10 Portugal 425
39.1.11 Spain 426
39.2 Iceland 427
39.3 Japan 428
39.4 Sweden 430
39.5 United Kingdom 431
39.6 United States of America 433
Bibliography 435
Index 439
