DOCSLIB.ORG

Print › Fixed Income Concepts | Quizlet

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Print › Fixed Income Concepts | Quizlet Fixed Income Concepts Study online at quizlet.com/_2b284 1. Duration Definition A measure of the sensitivity of an asset's value to interest rate movements (% change in price corresponding to a parallel shift in yields or YTM) ex - a 5yr duration means the bond will decrease in val by 5% if int rates rise 1% and increase in val by 5% if interest rates fall 1% 2. Duration Characteristics * tends to increase w/ maturity but at a decreasing rate * if an investor expects IR to fall, a bond with long duration would be appealing if expected to fall, chose a shorter dur * all else equal, higher rates=lower dur 3. Yield to Maturity * the one discount rate that equilibrates PV of cash flows to the market price * the IRR that a buyer would receive if they purchased the bond at market price 4. What are the key 1) assumes that the bond is held to maturity assumptions of YTM and that 2) the interim cash flows are reinvested at the same YTM 5. Macaulay Duration *Defined as the present-value wgted Definition avg time to receipt of cash flows, units=years 6. Problems with 1) assume that prices are a function of one-factor: YTM Macaulay/Modified 2) do not work for large IR changes (only the Duration linear component of the price/yield relationship) 3) not appropriate for sec with embedded options or where CF will be affected by IR changes 7. Analytic vs. numerical We say we have an analytic solution if we can actually solve the equation explicitly for the unknown solutions variable. In this case, it is easy to see that the explicit analytic solution is x = 5, and that this is the exact solution. If we were not so smart, we might develop an "algorithm" on a computer to solve this equation numerically. 8. Macaulay Duration Formula D = -(∂P/∂Y) 1/P (1+Y) (using partials) where P = Price Y=YTM 9. Macaulay Duration Analytic for fixed cash flow securities: Formula D = SIGMA (Pi*ti / V ) where Pi=PV of Cashflow i ti= time i V = PV of security (dirty price) 10. Modified Duration % change in price wrt a 1% change in YTM Definition 11. Modified Duration Formula MD = -∂P/∂Y * 1/P where P = dirty price, Y = YTM 12. Modified Duration - Modified Dur = Macaulay Duration / (1+YTM/n) Macaulay Duration Relationship 13. How can Modified Duration delta P = -modified duration * yield change be used to estimate the ex: MD=7, YTM change =+1%, P* = -7% change in price given a change in Yield? 14. Define Dollar Duration $ duration shows the effect of a change in yield (YTM) on the dollar value of a bond $D = -∂V/∂Y or Modified duration * price 15. Define PV01 and DV01 DV01 = $ val of a basis point = $D / 10,000 if currency is USD, DV01 = PV01 DV01 = DVBP, PV01 = PVBP 16. Define the Effective Duration ED = Option Adjusted Duration OAD = - (1/p) * (∂p/∂r) where r = parallel spot curve shock (one factor model) allows for CF to change as Yield changes as will happen with securities with embedded options 17. How is Effective Duration One method using a binomial tree: Calculated 1) Move the current YC up and down by a spec amt 2) recalculate the IR tree for each path 3) Re-estimate the CF along each path, holding OAS constant at current value 4) recalculate the avg price for the up and down trees Calc ED = {(Value IR down) - (Value IR up) } / (2V0deltaY) 18. Define Convexity Convexity measures the sensitivity of bond duration to changes in interest rates. It is the second order taylor expansion and accounts for the nonlinearity in the price/ytm relationship 19. Describe the effects of Assuming duration is negative: positive/negative convexity If pos convex = yields decr -> Slope (dp/dr) decreases -> Dur (-1/p*dp/dr) increases yields increase -> slope decreases -> Dur decreases higher convex = less affected by rise in IR, more affected by fall & higher price regardless of whether rates rise or fall 20. Explain the parametric approach assume Price is a function of N factors: P=P(F1,...FN) to risk mgmt *Param app investigates the price sensitivity of securities and ports to each risk factor in isolation, others fixed *Assume price is a function of a single factor, x: P = P (x) *Use a TS to estimate the behavior of percent changes around an arbitrary point x0 The first order expressions: -1/P (∂P/∂x) are partial dur (OAD, Key rate dur, spread dur, vol dur, prepay dur, etc.) * second order=convexities 21. Spread Duration The Approximate percentage change in a bond's price for a 100 basis point change in the credit spread assuming that the Treasury rate is unch Also can measures a bond's market price to a change in Option Adjusted Spread Does not account for prepayments 22. OAD/OAC drift drift = -∂OAD/∂r, OAC drift = -∂OAC/∂r 23. MBS Duration measures • Volatility duration - measures the % change in the price of an MBS that results from a 1% change in vol • Prepayment duration - % change in price resulting from a 1% change in the prepayment model • Current Coupon Spread Duration - % change in the price resulting from a 10bps change in cc spread • Refi Duration / Turnover Duration / Elbow duration - changes in refi dial, turnover dial, and elbow effect (lower costs=more refi) • Coupon Curve Duration measures the price sensitivity of MBS to changes in IR using the prices of MBS with the same agency and term. 24. Define a Bullet Bond Non-callable, coupon paying bond that pays principal at maturity (no amortization payments) amortizing bond - bond that repays part of principal along w/ coupon (mbs, abs) 25. Define Swap Spread Swap Spread = Swap Yield - Tsy Yield w/ same maturity regarded as a systematic credit premium spread over swap = specific credit risk 26. Define Nominal Nominal Yield spread: diff in YTM of a bond and YTM of benchmark Yield Spread 27. Define Zero Zero Volatility Spread (zspread) - The constant spread that, when added to the yield at each point on the spot Volatility Spread rate Treasury curve where a bond's cash flow is received, will make the price of a security equal to the present value of its cash flows. for option-free bonds, zspread=oas 28. Define OAS the flat spread which has to be added to the treasury yield curve in a pricing model (that accounts for embedded options) to discount a security payment to match its market price. OAS is hence model dependent. to calculate the OAS, the spot rate curve is given multiple interest rate paths. In other words, many different spot rate curves are calculated and the different interest rate paths are averaged An OAS accounts for interest rate vol and the prob of the prepayment of principal of the bond. 29. Define Discount Discount Margin (DM) - Bonds with var int rates are usually priced close to their par value. because the interest Margin rate (coupon) on a var rate bond adjusts to current IR based on changes in the bond's ref rate. The DM is the spread that, when added to the bond's current reference rate, will equate the bond's CF to its current P. 30. How is OAS 1) Estimate a series of IR paths representative of possible future rates so that no arbitrage exists calculated? 2) Project cash flows of the security along each of the paths 3) Estimate the OAS as the spread that when added to the yields used to discount cash flows, makes the avg of discounted cash flows equal to the price 31. How is Price • Using only duration: ∂ Price = (∂P * Duration) Approximation • Using duration + convexity: ∂ price = (∂yduration) + (0.5 Conv * (∂y)^2) done using duration/convexity? 32. Describe the YB 1) Determine which sector each position is in method for 2) For each position, assemble Risk Factors: Level of IR, vol of rates, credit spread, liquidity spread, hedging estimating TE risk, exchange rate risk, etc. 3) Decompose the covariance matrix for each sector risk factor set into principal components 4) Based on a multivariate normal distribution, the principal components cov matrix, and the initial values, sample a draw from the set of risk factors 5) Estimate the return of each position in the portfolio and benchmark (do this by estimating the change in return do to the change in each risk factor from its initial state and summing the differences) 6) repeat 4 and 5 10,000 times Rather than estimate the entire covariance matrix that would incorporate all relationships of risk factors and positions, YB uses principal components which can explain 90% of the total variance of each subsector 33. Define OAC/OAD describes how OAC and OAD change as rates change: drift OAD Drift = - dOAD/dr OAC drift = -dOAC/Dr 34. Define Constant measures empirical duration for securities in particular price ranges Dollar Duration 35. List some MBS All measure price sensitivity Duration Measures Volatility Duration - to volatility Prepayment Duration - to prepayments Current Coupon Spread Duration - to cc spread Refi Duration - to refinancing dial Coupon Curve Duration - to changes in IR using prices of mbs w/ same agency and term 36. Describe the Monte Delta normal = dur and conv are calculated at the current price and scenarios with IR changes use that duration Carlo Method of est and convexity estimate which will lead to false results for path-dependent securities where the cash flow is TE dependent upon the IR. Return dist of each security is assumed to be a linear function of the underlying risk factors and risk factors are assumed to be normally distributed.
Load more

Recommended publications
  • Investment Securities
    INVESTMENT SECURITIES INTRODUCTION Individuals seeking to invest their savings are faced with numerous financial products and degrees of risk. An individual investor can invest in a corporation as an equity owner or as a creditor. If an individual chooses to become an equity owner, he will hopefully benefit in the growth of the business. He can purchase common stock or preferred stock in the corporation. Assume an investor purchases 1,000 shares of ABC Corporation common stock. ABC has 100,000 shares of common stock outstanding. Our investor owns 1% (1,000 divided by 100,000 = 1%) of the outstanding shares. He will receive 1% of any dividends paid by the corporation and would receive 1% of any remaining assets upon dissolution of the corporation, after all creditors have been paid. Our investor would receive a stock certificate evidencing his ownership of 1,000 shares of common stock of ABC Corporation. He could sell his 1,000 shares, or any lesser amount, at any time. Our investor hopes to be able to sell his shares at a higher price than he paid for them. In other words, he hopes to realize a capital gain on the sale of the shares. Our investor would also like to receive dividends on his 1,000 shares. Assume ABC pays a quarterly divi- dend of $0.20 per share. Our investor would receive a quarterly dividend of $200 or an annual dividend of $800. The two main reasons an investor buys stock in a corporation are 1. To receive any dividends paid by the corporation 2.
    [Show full text]
  • Chapter 06 - Bonds and Other Securities Section 6.2 - Bonds Bond - an Interest Bearing Security That Promises to Pay a Stated Amount of Money at Some Future Date(S)
    Chapter 06 - Bonds and Other Securities Section 6.2 - Bonds Bond - an interest bearing security that promises to pay a stated amount of money at some future date(s). maturity date - date of promised final payment term - time between issue (beginning of bond) and maturity date callable bond - may be redeemed early at the discretion of the borrower putable bond - may be redeemed early at the discretion of the lender redemption date - date at which bond is completely paid off - it may be prior to or equal to the maturity date 6-1 Bond Types: Coupon bonds - borrower makes periodic payments (coupons) to lender until redemption at which time an additional redemption payment is also made - no periodic payments, redemption payment includes original loan principal plus all accumulated interest Convertible bonds - at a future date and under certain specified conditions the bond can be converted into common stock Other Securities: Preferred Stock - provides a fixed rate of return for an investment in the company. It provides ownership rather that indebtedness, but with restricted ownership privileges. It usually has no maturity date, but may be callable. The periodic payments are called dividends. Ranks below bonds but above common stock in security. Preferred stock is bought and sold at market price. 6-2 Common Stock - an ownership security without a fixed rate of return on the investment. Common stock dividends are paid only after interest has been paid on all indebtedness and on preferred stock. The dividend rate changes and is set by the Board of Directors. Common stock holders have true ownership and have voting rights for the Board of Directors, etc.
    [Show full text]
  • Investments 101: Fixed Income & Public Equities
    NCPERS Trustee Education Seminar FIXED INCOME 101 May 14, 2016 Steve Eitel Senior Vice President Senior Institutional Client Advisor [email protected] 312-384-8259 What is a bond or fixed income security • A bond represents a loan to a government or business • Fixed income securities are debt obligations promising a series of pre-specified payments at pre-determined points in time Investor Loans $1000 Annual Interest Payments Company XYZ Repayment of Initial $1000 Loan at Maturity What Does the Global Bond Market Look Like? • U.S. makes up a little over a 1/3rd of the global bond market • Global bond market as of June 30, 2014 was approximately $87.2T according to the Bank of International Settlements statistical annex. Types of Bonds Government Bonds • Governments and Instrumentalities issue debt obligations to investors • Proceeds are used to finance the operation of the U.S. government • Types of Government securities include: - U.S. Treasury Bills, Notes, Bonds, Inflation-Protected Securities (TIPs), Zero Coupons - U.S. Agency Obligations/Government Sponsored Entities (GSE’s) - Federal National Mortgage Association (FNMA/Fannie Mae) - Federal Home Loan Mortgage Association (Freddie Mac) - Federal Farm Credit Bank (FFCB) - Federal Home Loan Bank (FHLB) - Tennessee Value Authority (TVA) - Small Business Association (SBA) - Direct U.S. Backed Agency - Government National Mortgage Association (GNMA/Ginnie Mae) - Foreign Government Issuers Types of Bonds Corporate Bonds • Corporations issue fully taxable debt obligations to investors • Proceeds are used to refinance existing bonds, fund expansions, mergers and acquisitions, fund operations, fund research and development • Types of Corporate debt securities include: - Secured Debt: backed by a specific pledged asset/collateral - Unsecured Debt: aka Debentures; backed by good faith and credit of borrower - Yankee bonds: foreign corporations issuing bonds in the U.S.
    [Show full text]
  • BASIC BOND ANALYSIS Joanna Place
    Handbooks in Central Banking No. 20 BASIC BOND ANALYSIS Joanna Place Series editor: Juliette Healey Issued by the Centre for Central Banking Studies, Bank of England, London EC2R 8AH Telephone 020 7601 3892, Fax 020 7601 5650 December 2000 © Bank of England 2000 ISBN 1 85730 197 8 1 BASIC BOND ANALYSIS Joanna Place Contents Page Abstract ...................................................................................................................3 1 Introduction ......................................................................................................5 2 Pricing a bond ...................................................................................................5 2.1 Single cash flow .....................................................................................5 2.2 Discount Rate .........................................................................................6 2.3 Multiple cash flow..................................................................................7 2.4 Dirty Prices and Clean Prices.................................................................8 2.5 Relationship between Price and Yield .......................................................10 3 Yields and Yield Curves .................................................................................11 3.1 Money market yields ..........................................................................11 3.2 Uses of yield measures and yield curve theories ...............................12 3.3 Flat yield..............................................................................................12
    [Show full text]
  • Bond Risk, Bond Return Volatility, and the Term Structure of Interest Rates
    Bond Risk, Bond Return Volatility, and the Term Structure of Interest Rates Luis M. Viceira1 Forthcoming International Journal of Forecasting This draft: January 2010 Abstract This paper explores time variation in bond risk, as measured by the covariation of bond returns with stock returns and with consumption growth, and in the volatility of bond returns. A robust stylized fact in empirical finance is that the spread between the yield on long-term bonds and short-term bonds forecasts positively future excess returns on bonds at varying horizons, and that the short-term nominal interest rate forecasts positively stock return volatility and exchange rate volatility. This paper presents evidence that movements in both the short-term nominal interest rate and the yield spread are positively related to changes in subsequent realized bond risk and bond return volatility. The yield spread appears to proxy for business conditions, while the short rate appears to proxy for inflation and economic uncertainty. A decomposition of bond betas into a real cash flow risk component, and a discount rate risk component shows that yield spreads have offsetting effects in each component. A widening yield spread is correlated with reduced cash-flow (or inflationary) risk for bonds, but it is also correlated with larger discount rate risk for bonds. The short rate forecasts only the discount rate component of bond beta. JEL classification:G12. 1Graduate School of Business Administration, Baker Libray 367, Harvard Univer- sity, Boston MA 02163, USA, CEPR, and NBER. Email [email protected]. Website http://www.people.hbs.edu/lviceira/. I am grateful to John Campbell, Jakub Jurek, André Per- old, participants in the Lisbon International Workshop on the Predictability of Financial Markets, and especially to two anonymous referees and Andréas Heinen for helpful comments and suggestions.
    [Show full text]
  • 1. Securities Markets, Investment Securities, and Economic Factors
    1. Securities Markets, Investment Securities, and Economic Factors What is a Security Investment of Money In pooled interest With expectation of Profit Managed by third party 2 primary types, and a third major; Equity (Ownership) Bonds (Debt) Money Markets (specific short term debt) There are others, those are the biggies, including Variable Insurances. Updated: August 2017 Equity Common Stock Primarily capital appreciation Voting rights Potential dividends Lowest liquidation claims in bankruptcy Preemptive Rights Round Lots (100) Updated: August 2017 Cumulative Voting Allocate all votes any way, including all for 1, benefits small owners. Statutory Voting Can allocate 1 vote per share per seat, benefits large owners. Updated: August 2017 Preferred stock Stated interest rate on certificate Higher liquidation claims in bankruptcy than common stock No voting No proportional ownership rights Par Value $100 Attachments; Straight Preferred: Nothing other than stated rate if BOD declares dividend. Callable: Issuer can force investor to sell the security to them. Higher stated return than straight. Convertible: Investor can convert the security into common shares. Lower stated return than straight. 100/(Conversion Factor)=(Number of Shares). Participating: If BOD declares larger dividend, this preferred gets larger dividend. Lower stated return than straight Cumulative: If dividends missed, all missed dividends must be paid to cumulative preferred owners before anyone else gets new dividend. Lower stated return than straight. Updated: August 2017 Broker/Dealer Updated: August 2017 Bonds/Debt Needed Definitions Par Face amount, amount paid on maturity, for bonds is $1000. ($100 for preferred stock) Coupon Stated interest rate, or nominal yield printed on the Certificate.
    [Show full text]
  • Hicks-Arrow Prices for US Federal Debt 1791-1930
    Costs of Financing US Federal Debt: 1791-1933∗ George Hall,† Jonathan Payne,‡ Thomas J. Sargent,§ Bálint Szőke¶ August 26, 2021 Abstract We use computational Bayesian methods to estimate parameters of a statistical model of gold, greenback, and real yield curves for US federal debt from 1791 to 1933. Posterior probability coverage intervals indicate more uncertainty about yields during periods in which data are especially sparse. We detect substantial discrepancies between our approximate yield curves and standard historical series on yields on US federal debt, especially during War of 1812 and Civil War surges in government expenditures that were accompanied by units of account ambiguities. We use our approximate yield curves to describe how long it took to achieve Alexander Hamilton’s goal of reducing default risk premia in US yields by building a reputation for servicing debts as promised. We infer that during the Civil War suspension of convertibility of greenback dollars into gold dollars, US creditors anticipated a rapid post war return to convertibility at par, but that after the war they anticipated a slower return. JEL classification: E31, E43, G12, N21, N41 Key words: Big data, default premia, yield curve, units of account, gold standard, government debt, Hamil- tonian Monte Carlo, Julia, DynamicHMC.jl, pricing errors, specification analysis. ∗We thank Clemens Lehner for outstanding research assistance and Min Wei and audiences at the Minnesota Workshop in Macroeconomic Theory and a University of Sydney seminar for suggestions. The views expressed here are those of the authors and do not necessarily represent the views of the Federal Reserve Board or its staff.
    [Show full text]
  • Chapter 10 Bond Prices and Yields Questions and Problems
    CHAPTER 10 Bond Prices and Yields Interest rates go up and bond prices go down. But which bonds go up the most and which go up the least? Interest rates go down and bond prices go up. But which bonds go down the most and which go down the least? For bond portfolio managers, these are very important questions about interest rate risk. An understanding of interest rate risk rests on an understanding of the relationship between bond prices and yields In the preceding chapter on interest rates, we introduced the subject of bond yields. As we promised there, we now return to this subject and discuss bond prices and yields in some detail. We first describe how bond yields are determined and how they are interpreted. We then go on to examine what happens to bond prices as yields change. Finally, once we have a good understanding of the relation between bond prices and yields, we examine some of the fundamental tools of bond risk analysis used by fixed-income portfolio managers. 10.1 Bond Basics A bond essentially is a security that offers the investor a series of fixed interest payments during its life, along with a fixed payment of principal when it matures. So long as the bond issuer does not default, the schedule of payments does not change. When originally issued, bonds normally have maturities ranging from 2 years to 30 years, but bonds with maturities of 50 or 100 years also exist. Bonds issued with maturities of less than 10 years are usually called notes.
    [Show full text]
  • Local Currency Sovereign Risk∗
    Local Currency Sovereign Risk∗ Wenxin Du † Jesse Schreger ‡ Federal Reserve Board Harvard University April 8, 2015 Abstract We introduce a new measure of emerging market sovereign credit risk: the local cur- rency credit spread, defined as the spread of local currency bonds over the synthetic local currency risk-free rate constructed using cross-currency swaps. We find that local currency credit spreads are positive and sizable. Compared with credit spreads on foreign currency- denominated debt, local currency credit spreads have lower means, lower cross-country cor- relations, and are less sensitive to global risk factors. We discuss several major sources of credit spread differentials, including selective default, capital controls, covariance between currency and credit risk, and various financial market frictions. Keywords: local currency, sovereign debt, currency swaps JEL Classifications: F31, F34, G15 ∗We are especially grateful to John Campbell, Gita Gopinath, Robin Greenwood, Kenneth Rogoffand Luis Viceira for their invaluable advice and guidance. We thank the editor Kenneth Singleton and two anonymous referees, Cristina Arellano, Javier Bianchi, Emmanuel Farhi, Donna Fletcher, Jeffrey Frankel, Jeffry Frieden, Jakub Jurek, Sebnem Kalemli-Ozcan, Guido Lorenzoni, Matteo Maggiori, Rui Mano, Michael Michaux, Michael Rashes, Helene Rey, Jeremy Stein, Lawrence Summers, Vivian Yue and Adrien Verdelhan; and seminar participants at the AQR Capital Management, Cass Business School, Federal Reserve Board, Harvard, IMF Institute, Maryland, Melbourne, NBER IFM, Stanford GSB, State Street, Tsinghua, UCLA Anderson, Wharton, UCSD, UVA Darden, Western Finance Association, and the World Bank for comments and suggestions. We are also indebted to numerous people at governments, central banks, investment banks, the Emerging Market Trading Association, and the Luxembourg Stock Exchange who helped us gather data on emerging market fixed income securities.
    [Show full text]
  • Inflation and the Stock Market: Understanding the “Fed Model”∗
    Inflation and the Stock Market: Understanding the “Fed Model”∗ Geert Bekaert† Columbia University and NBER Eric Engstrom‡ Federal Reserve Board of Governors This Draft: September 2008 JEL Classifications G12, G15, E44 Keyphrases Money illusion, Equity premium, Countercyclical risk aversion, Fed model, Inflation, Economic Uncertainty Dividend yield, Stock-Bond Correlation, Bond Yield Abstract: The so-called Fed model postulates that the dividend or earnings yield on stocks should equal the yield on nominal Treasury bonds, or at least that the two should be highly correlated. In US data there is indeed a strikingly high time series correlation between the yield on nominal bonds and the dividend yield on equities. This positive correlation is often attributed to the fact that both bond and equity yields comove strongly and positively with expected inflation. While inflation comoves with nominal bond yields for well-known reasons, the positive correlation between expected inflation and equity yields has long puzzled economists. We show that the effect is consistent with modern asset pricing theory incorporating uncertainty about real growth prospects and also habit-based risk aversion. In the US, high expected inflation has tended to coincide with periods of heightened uncertainty about real economic growth and unusually high risk aversion, both of which rationally raise equity yields. Our findings suggest that countries with a high incidence of stagflationshouldhaverelatively high correlations between bond yields and equity yields and we confirm that this is true in a panel of international data. ∗This work does not necessarily reflect the views of the Federal Reserve System or its staff. In particular, our use of the term "Fed Model" reflects only conventional parlance among finance practicioners for this common valuation model.
    [Show full text]
  • Getting Tipsy: Have We Reached the Tipping Point for Tips?
    GETTING TIPSY: HAVE WE REACHED THE TIPPING POINT FOR TIPS? GETTING TIPSY: HAVE WE REACHED THE TIPPING POINT FOR TIPS? By: Round Table Wealth Management Treasury Inflation Protected Securities (or “TIPS”) provide investors with a useful tool to manage inflation risk and preserve purchasing power. The unique properties of TIPS can make them an attractive investment; however, there are important considerations in determining if they are appropriate for a given investor. This paper examines the advantages and drawbacks of TIPS and assesses the potential for use today and in the future. BOND BASICS The coupon received from a fixed income security is a function of multiple risks for which the investor is compensated. Investors face credit, duration, reinvestment, and inflation risk when holding a bond and each risk commands additional compensation or yield. Credit risk is debtor-specific, referring to the risk of not receiving timely interest or principal payments. Duration and reinvestment risks can be bundled together to represent a “term premium,” or added compensation for the increased uncertainty of investing in a longer-maturity bond. Duration risk refers to the impact changes in market interest rates can have on the value of a security, while reinvestment risk highlights the uncertainty of reinvesting coupon income at changing interest rates over time. Inflation risk is a product of the economy and describes how an increase in the prices of day-to-day living expenses can reduce the real value of returns or purchasing power of income. By investing in different types of fixed income securities, investors can choose which risk to which they are exposed.
    [Show full text]
  • University of Cape Town
    The copyright of this thesis vests in the author. No quotation from it or information derived from it is to be published without full acknowledgementTown of the source. The thesis is to be used for private study or non- commercial research purposes only. Cape Published by the University ofof Cape Town (UCT) in terms of the non-exclusive license granted to UCT by the author. University An Investigation of Short Rate Models and the Pricing of Contigent Claims in a South African Setting Chris Jones 29 November, 2010 Town Cape Presented for the Degree of Mastersof of Science in Mathematics of Finance in the Department of Statistical Science, University of Cape Town Supervisor: Professor Ronald Becker University Plagiarism Declaration 1. I know that plagiarism is wrong. Plagiarism is to use another's work and pretend that it is one's own. 2. Each significant contribution to, and quotation in this dissertation from the work of other people has been attributed, and has been cited and referenced. 3. This dissertation is my own work. Town 4. I have not allowed, and will not allow, anyone to copy my work with the intention of passing it off as his or her own work. Cape of University 2 Abstract This dissertation investigates the dynamics of interest rates through the modelling of the short rate { the spot interest rate that applies for an in- finitesimally short period of time. By modelling such a rate via a diffusion process, one is able to characterize the entire yield curve and price plain vanilla options. The aim is to investigate which of the more popular short rate models is best suited for pricing such options, which are actively traded in the market.
    [Show full text]