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Demystifying Fixed Income Analytics: A Practical Guide book cover

1st Edition

Demystifying Fixed Income Analytics A Practical Guide

By Kedar Nath Mukherjee Copyright 2021
    490 Pages 45 B/W Illustrations
    by Routledge India

    490 Pages 45 B/W Illustrations
    by Routledge India

    490 Pages 45 B/W Illustrations
    by Routledge India
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    This book discusses important aspects of fixed income securities in emerging economies.

    Key features

    • Clarifies all conceptual and analytical aspects of fixed income securities and bonds, and covers important interest rate and credit derivative instruments in a simple and practical way.

    • Examines topics such as classifications of fixed income instruments; related risk-return measures; yield curve and term structure of interest rates; interest rate derivatives (forwards, futures and swaps), credit derivatives (credit default swaps); and trading strategies and risk management.

    • Provides step-by-step explanation of fixed income products by including real-life examples, scenarios and cases, especially in the context of emerging markets.

    • Presents consistent reference of actual market practices to make the chapters practice oriented while maintaining a lucid style complemented by adequate reading inputs and clear learning outcomes.

    • Includes complete solutions of numericals and cases for all chapters as an eResource on the Routledge website to aid understanding.

    The book will serve as a ready guide to both professionals from banking and finance industry (fixed income/bond dealers; fund/investment/portfolio managers; investment bankers; financial analysts/consultants; risk management specialists), and those in academics, including students, research scholars, and teachers in the fields of business management, banking, insurance, finance, financial economics, business economics, and risk management.

    Lists of Figures, Tables, Case Studies

    Foreword by G. Mahalingam

    Preface

    Acknowledgements

    Abbreviations

     

    Chapter 1: Fixed Income Securities Market: An Overview

    • Fixed Income Securities Market – An Introduction

    • Global Debt Markets - A Review

    • Debt Markets in India

      • Govt. Debt Market in India

      • Non-Govt. Securities / Corporate Bond Market in India

      • Primary Debt Market in India (Govt. vs. Non-Govt. Debts)

      • Secondary Market Trading in Govt. Securities

      • Secondary Market Trading in Non-Govt. Securities

    • Issuance and Settlement of Debt Securities in India

      • Primary Issuance and Settlement in Govt. Securities

      • Issuance and Settlement in Non-Govt. Securities

    • Issuance and Settlement of Debt Securities in India

      • Primary Issuance and Settlement in Govt. Securities

      • Issuance and Settlement in Non-Govt. Securities

      • Settlement for Secondary Market Trading in Debt Securities in India

    • Various Participants in the Debt Securities market

      • Major Investors in Indian Debt Market

      • Intermediaries in Indian Debt Market

    • Self-Learning Exercise

    • Bibliography

    Chapter 2: Fixed Income Instruments: Various Classifications

    • Basic Features of Fixed Income Security

    • Debt Market Instruments: Classification

      • Classification of Debt Instruments based on Markets

      • Classification of Debt Instruments based on their Feature

        • Fixed Rate Bond, Floating Rate Bond, Zero Coupon Bond, STRIPS, Bond with Call and Put Option, Step-up/Step-down Bond, ABS/MBS, Tax Saving Bond, Perpetual Bond, Junk Bond, Covered Bond, Secured/Unsecured Bond, Inflation Indexed Bond, Basel III Bond, Green Bond

      • Issuing Sectors and Sub-Sectors Wise Classification of Debt Instruments

      • Classification of Debt Instruments based on Currency of Debt Issue

      • Regulatory Classification of Debt Instruments (in India)

    • Self-Learning Exercise

    • Bibliography

    Chapter 3: Basic Statistics

    • Measures of Central Tendency

      • Arithmetic Mean/Average

      • Moving Average

      • Median

      • Mode

    • Measures of Dispersion

      • Absolute Measures of Dispersion (Range, Mean Deviation, Standard Deviation, Joint Standard Deviation)

      • Relative Measures of Dispersion (Coefficient of Variation, Coefficient of Mean Deviation)

    • Skewness and Kurtosis

    • Correlation and Regression

    • Probability Distribution

    • Test of Hypothesis

    • Self-Learning Exercise

    • Bibliography

    Chapter 4: Risk and Return Measures

    • Risk and Return in Bonds: Meaning and Linkages

    • Risks Associated with Fixed Income Securities

      • Interest Rate Risk

      • Reinvestment Risk

      • Yield Curve Risk

      • Liquidity Risk

      • Call Risk (Timing Risk)

      • Credit Risk

      • Legal Risk

      • Foreign Exchange Risk

      • Volatility Risk

      • Sovereign Risk (Country Risk, Political Risk)

    • Return Measures for Fixed Income Securities

      • Nominal Return / Coupon Rate (CR)

      • Current Yield (CY)

      • Average Return or Yield to Maturity (YTM)

      • Return till the Call (Put) Date (YTC / YTP)

      • Yield to Worst (YTW) and Yield to Best (YTB)

      • Total Return (TR)

    • Limitations of Different Yield Measures

    • Case Study: Analysis of Returns on a Debt Portfolio

    • Self-Learning Exercise

    • Bibliography

    Chapter 5: Term Structures of Interest Rates

    • Interest Rates: Meaning and Different Types

    • Some Important Interest Rates in Indian Debt Market

      • Benchmark Rate

      • G-Sec. Yield

      • T-Bill Rate

      • Swap Rate

    • Major Determinants of Bond Yields

    • Term Structure of Interest Rates: Different Types

      • Yield Curve

      • Methods of Constructing Yield Curve

      • Zero Coupon Yield / Spot Rate Curve

      • Forward Rate Curve

      • The Credit Spread and Non-GSec. ZCYC

    • Theories of Interest Rate Term Structure

      • Expectations Theory

      • Liquidity Preference Theory

      • Market Segmentation Theory

      • Preferred Habitat Theory

    • Case Study: Term Structure of Interest Rates in India

    • Self-Learning Exercise

    • Bibliography

    Chapter 6: Pricing and Valuation Techniques

    • Valuation of Bond: Meaning

    • Valuation of a Bond: Broader Steps

    • Valuation of Bond: Important Issues

      • Bond Valuation in-between Two Coupon Payment Dates / with Accrued Interest

      • Selection of Day Count Conventions

      • Selection of Single or Multiple Discounting Rates

      • Presence of Some Special Feature (s)

    • Valuation of Floating Rate Bond

    • Valuation of Bond with Embedded Options

    • Valuation of FI Securities: RBI-FIMMDA Guidelines

    • Case Study: Bond Valuation

    • Self-Learning Exercise

    • Bibliography

    Chapter 7: Interest Rate Sensitivity Measures

    • Bond Price Sensitivity to Interest Rates: Meaning

    • Price-Yield Relationship

    • Various Interest Rate Sensitivity Measures

      • Duration or Macaulay Duration

        •

      • Modified Duration

      • Effective Duration

      • M-Duration of Floating Rate Bond

      • Price Value of a Basis Point (PVBP) or PV01

      • Portfolio Sensitivity Measure

    • Limitations of Duration/M-Duration/PV01

      • Linearity in the Price-Yield Relations

      • Parallel Shift in Yield Curve

    • Convexity: A Supplement to M-Duration

      •

    • Case Study: Interest Rate Sensitivity of a Bond Portfolio

    • Self-Learning Exercise

    • Bibliography

    Chapter 8: Financial Derivatives Contract

    • Financial Derivatives: Meaning & Types of Contracts

      • Exchange Traded Derivatives

      • Over-the-Counter Derivatives

      • Forwards

      • Futures

      • Swaps

      • Options

    • Financial Derivatives Market: Worldwide & in India

    • Participants in Financial Derivatives Market

    • Application of Financial Derivatives

    • Self-Learning Exercise

    • Bibliography

    Chapter 9: Interest Rate Futures

    • Interest Rate Futures Contract: Meaning & Product Structure

      • How Does Interest Rate Futures Contract Work

    • Interest Rate Futures Market in India

    • Important Features of IRF Contract

      • Underlying Instrument (Actual or Notional)

      • Deliverable Basket

      • Conversion Factor

      • Implied Repo Rate

      • Cheapest-to-Deliver Issue

    • Interest Rate Futures Contract: Product Structures in India

      • T-Bills Futures Contract in India

      • Single Bond Futures Contract in India

    • Pricing of Interest Rate Futures

    • Method of Settlement

      • Mark-to-Market (MTM) Settlement

      • Final Settlement

    • Market participants

    • Advantage / Usefulness of IRF Contract

      • Hedging Underlying Exposure

      • Use of Arbitrage Opportunity

      • Directional Trading

      • Asset-Liability / Duration Management

    • Case Study: Hedge Effectiveness of Bond Futures Contracts in India

    • Self-Learning Exercise

    • Bibliography

    Chapter 10: Forward Rate Agreement and Interest Rate Swaps

    • FRA & IRS: Meaning & Product Structure

    • FRA and IRS Market in India

    • Pricing of Forward Rate Agreement

    • Settlement of a FRA Deal

    • Different Types of Interest Rate Swaps

    • Important Structures of IRS in India

      • INBMK Swap

      • MIBOR Overnight Index Swap

      • MIFOR Overnight Index Swap

    • Theory of Comparative Advantage in IRS

    • Pricing and Valuation of Interest Rate Swap

      • Pricing of IRS

      • Marked-To-Market (MTM) of INBMK Swaps

      • Marked-to-Market Valuation of MIBOR-OIS:

    • Settlement of Periodical Interest in IRS Contracts

      • Settlement of Periodical Interest in INBMK Swaps

      • Settlement of Periodical Interest in MIBOR OIS

    • Offsetting / Premature Unwinding / Cancellation of FRA / IRS

      • Premature Unwinding / Termination of INBMK Swaps

      • Premature Unwinding / Termination of OIS

    • Usefulness of FRA / Interest Rate Swap

    • Risk in FRA / Interest Rate Swap

      • Interest Rate Risk

      • Credit Risk

    • Documentation for FRA / Interest Rate Swap

    • Case Study: Overnight Index Swap (Focus: MTM Valuation, PV01, and Premature Cancellation

    • Self-Learning Exercise

    • Bibliography

    Chapter 11: Interest Rate Options and Structured Products

    • Interest Rate Options: Meaning & Structures

    • Pricing of Interest Rate Options

      • Intrinsic Value

      • Time Value

      • Factors Affecting Options’ Price

    • Pricing Models for Interest Rate Options

      • Arbitrage-free Binomial Option Pricing Model

    • Interest Rate Caps, Floors, and Collar: Meaning & Structures

    • Case Study: Cost-Effectiveness of Interest Rate Derivatives

    • Self-Learning Exercise

    • Bibliography

    Chapter 12: Credit Default Swaps

    • Meaning and Definition of Credit Derivatives

      • Credit Default Swaps (CDS)

    • History and Growth of Credit Default Swaps

      • Reasons for High Growth in CDS Market

    • Different Types of Credit Default Swaps

    • Features of Credit Default Swaps

    • Current Scope and Futures Challenges for CDS in India

    • Self-Learning Exercise

    • Bibliography

    Chapter 13: Trading and Management Strategies

    • Bond Portfolio Management: Meaning

      • Setting Investment Objectives

      • Development and Implementation of Portfolio Management Strategy

      • Portfolio Monitoring and Necessary Adjustments:

    • Passive Management Strategies

      • Bond Indexing

      • Cash Flow Matching

      • Classical Immunization

      • Advantages and Limitations of Passive Strategy:

    • Active Management Strategies

      • Important News affecting Interest Rates and Bond Yields:

    • Yield Curve Shifts and Different Types of Active Management Strategies

      • No shift in the Yield Curve: Riding the Yield Curve

      • Parallel YC Shift: Shortening Portfolio’s Duration

      • Parallel YC Shift: Lengthening Portfolio’s Duration

      • Un-Parallel Shift (YC Shifts with Twists): Yield Curve Flattening, Yield Curve Steepening

      • Un-Parallel Shift (YC Shifts with Humpedness): Positive Butterfly, Negative Butterfly

      • Un-Parallel Shift in the YC: Possible Strategies (Bullet Strategy, Barbell Strategy, Ladder Strategy)

    • Strengths and Weaknesses for Active Management

    • Bond Portfolio Optimization

    • Self-Learning Exercise

    • Bibliography

    Chapter 14: Risk Management (Focus: Market Risk)

    • Risk Management and Basel Accord: An Overview

      • Market Risk

      • Interest Rate Risk

      • Liquidity Risk

      • Credit Risk

      • Non-Financial or Operational Risk

    • Measuring Risk in Fixed Income Securities

      • Standardized Approach

      • Internal Model Approach (IMA)

    • Value at Risk: A Risk Measurement Tool

      • Variance-Covariance (VCV) Approach

      • Historical Simulation (HS) Approach

      • Monte-Carlo Simulation (MCS) Approach

    • Expected Shortfall: A Risk Measure beyond VaR

    • Back Testing and Stress Testing of Risk Measurement Tool

      • Back Testing VaR & ES Estimate

      • Stress Testing VaR & ES Estimate

    • Market Risk Capital Charge on Fixed Income Portfolio of a Bank

      • Market Risk Capital Charge under SMM

      • Limitations of Standardized Method to Estimate MRCC

      • Market Risk Capital Charge under IMA

    • Case Study: Estimation of MRCC on FI Portfolio under Advanced (VaR) Method

    • Self-Learning Exercise

    • Bibliography

    　

    Glossary

    Index

    　

    Biography

    Kedar Nath Mukherjee is Assistant Professor at National Institute of Bank Management, Pune, Maharashtra, India. He has extensive experience in providing training to senior and middle-level executives in treasury and risk management departments of commercial, investment, and cooperative banks, primary dealers, insurance companies, pension funds, public sector undertakings, corporate treasuries, etc., on the topics of fixed income securities, bond portfolio management, investment management, risk management, and financial derivatives. Besides professional training, he also teaches courses in PGDM programmes and undertakes consultancy activities. He has published research papers in various journals, and the monograph Fixed Income Securities: Valuation, Risk and Risk Management.

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