INDEX

Note: Page numbers followed by e refer to exhibits. pathwise valuation in, 419–421, 420e, 421e volatility and, 407–408 A Arbitrage opportunity, 398, 399–400, 400e ABS. See Asset-backed securities ARMs (adjustable-rate mortgages), 165–166 Acceleration provision, 439 Asian-Pacifi c Aggregate Index, 56 Accounting defeasance, 661 Asset allocation, 701–703, 702e Accounts receivable Asset-backed securities (ABS), 5–6, 153–194 asset-backed securities and, 154, 865 assets used to create, 5, 12, 13–14, 154, 865 Accrued interest, 107–109 auto loan asset-backed securities and, Accumulated benefi t obligation (ABO), 676, 677, 187–188 683, 686 benefi ts of securitization for, 154–155 Active management, 617, 617e, 690 collateral for, 12 Active strategies. See Yield curve collateralized debt obligations and, 191–194 strategies commercial mortgage-backed securities Active return, 615 (CMBSs) and, 182–187 Active risk, 615 rate and frequency of, 6–7 Add-on rates, 125–127 credit card asset-backed securities and, Adjustable-rate mortgages (ARMs), 165–166 190–191 Advance refunding, 438 currency denominations of, 7–8 Affi rmative covenants, 15, 295–296 defi ned, 5, 153–154 Agency bonds, 69 issuers of, 5–6 Agency residential mortgage-backed securities of, 6 (RMBS), 169, 864 mortgage-backed, 6, 154. See also Mortgage- ALM. See Asset-liability management backed securities (MBS) American-style calls, 35, 437 non-mortgage, 187–194 Amortization, 166 of, 6 Amortizing bonds, 23–25, 24e repayment sources for, 12 Amortizing loans, 166 residential mortgage loans and, 164–167 Analytics, bond, 492–493 residential mortgage-backed securities and, Arbitrage free models, 397–426 169–182 Arbitrage-free valuationCOPYRIGHTED framework, securitization MATERIAL process and, 5, 153, 155–163, 397–426 157e arbitrage opportunity and, 399–400, 400e special legal entity for, 11 binomial interest rate tree and, 403–407, 404e, structured fi nancial instruments and, 77 405e, 407e, 410–414, 410e–414e yield measures for, 10 bond value at nodes in, 408, 408e Asset-driven liabilities (ADL), 645, 646 defi ned, 398–399 Asset-liability committees (ALCOs), 645 fi xed-income securities and, 400–401 Asset-liability management (ALM), 611, 644, interest rate volatility in, 401–403 645, 611 law of one price and, 399 Asset spread, 140 Monte Carlo method in, 423–424 AT&T, 305, 306e, 837–838, 838e option-free bonds and, 417–418, 418e, 419e Auctions, 58, 60–62, 61e

895

bindex 895 24 August 2019 10:07 AM 896 Index

Australia Barclays Global Corporate Index, 863 bonds in, 19, 31, 32, 67, 438, 558, 810, 815 Barclays Global Credit Index, 860 mortgages in, 166 Barclays Global High Yield Index, 823 Authorized participants, 699 Barclays Global Securitized Index, 863 Auto loan asset-backed securities (ABS), Barclays US Aggregate (Bond) Index, 56, 606, 187–188 607e, 608, 701, 702, 702e Average credit rating, 844–845, 844e Barclays US Aggregate Index, 691, 692, 865 Average life, 174 Barclays US Corporate Index, 606, 607e, 857 Average OAS, 845 Barclays US Corporate High-Yield Index, 606, Average spread duration, 845 607e, 608 Barclays US Credit Index, 832 B Barclays US High Yield Index, 843 Backup lines of credit, 72 Barclays US TIPS, 606, 607e Backup liquidity lines, 72 Barclays US Treasury Bond 10-Year Term, 606, BADLAR (Buenos Aires Deposits of Large 607e Amount Rate), 188 Base prospectus, 157n1 Balance sheets, 287 Basis points (bps) Balloon maturity provisions, 184 benchmark spread and, 139 Balloon payments, 23, 184 bond price quotations and, 77 Balloon risk, 184 defi ned, 7 Bank for International Settlements (BIS), option-adjusted spread and, 142 356, 579 spread over the benchmark and, 113 Bank guarantees, 15, 41 yield spreads and, 113 Bank lines, 287 Basis trades, 594 Bank loans BBA (British Bankers’ Association), 52 asset-backed securities and, 5, 154, 865 Bearer bonds, 19 as corporate debt, 71 Bear fl attener, 656 Bank Recovery and Resolution Directive Bear steepener, 656 (BRRD), European Union, 558 Below investment grade bonds, 272 Bankruptcy, 162–163, 574–575 Benchmark bonds, 839 priority of claims in, 268–269 Benchmark issues, 65 Bankruptcy-remote vehicles, 12, 13, 156, 162, Benchmark rate, 113 195, 557 Benchmarks Banks credit strategy and, 832, 833 asset–liability committees (ALCOs) for loans Monte Carlo method with, 424 by, 645 spread over, 113 non-investment-grade bond holdings of, 5 spreads and, 138 short-term funding alternatives available to, Benchmark selection, 701–703, 702e 82–86 Benchmark spread, 139, 826–827 Barbell portfolio, 704, 705e, 742–746, Bermuda-style calls, 35, 437, 438 743e–744e, 745e, 752–755, 753e–755e, Bermuda-style putable bonds, 438 787–788, 787e, 788e, 789–790, 789e–791e Best eff ort off erings, 59 Barclays bond indexes, 833 Bid-ask spread, 63, 855–856, 855e Barclays Capital US Aggregate Bond Index, Bid-off er spread, 63 169n5 Bilateral loans, 71 Barclays Euro Corporate Index, 832 Binomial interest rate tree, 403–407, 404e, 405e, Barclays Global Aggregate Bond Index, 56, 607, 407e, 410–414, 410e–414e, 451, 452e 607e, 611 BIS (Bank for International Settlements), 356, Barclays Global Aggregate–Corporate 579 Index, 823 Black–Scholes–Merton option pricing model, Barclays Global Aggregate Index, 690, 691, 818 374, 523, 526

bindex 896 24 August 2019 10:07 AM Index 897

Bloomberg Barclays, 298, 833 Bond indenture, 10–18, 296 Bloomberg Barclays bond indexes, 833 alternative methods for passive exposure in, Bloomberg Barclays Capital US Aggregate Bond 695–696 Index, 169n5 collateral backing of, 10, 12–14 Bloomberg Barclays Euro Corporate Index, 832 covenants and, 10, 15–16 Bloomberg Barclays Global Aggregate Bond credit enhancements and, 14–15 Index, 56, 607, 607e, 611 defi ned, 10 Bloomberg Barclays Global Aggregate–Corporate domestic vs. foreign, 18–19, 217 Index, 823 legal identity of bond issuer and, 11–12 Bloomberg Barclays Global Aggregate Index, 690, risk and, 11 691, 818 source of repayment proceeds and, 12 Bloomberg Barclays Global Corporate trustees and, 10–11 Index, 863 Bond markets, 57–64 Bloomberg Barclays Global Credit Index, 860 classifi cation by sector, 5 Bloomberg Barclays Global High Yield Index, global, 18, 620, 622, 692 823 liquidity in, 619–622 Bloomberg Barclays Global Securitized Index, national, 18 863 portfolio diversifi cation and, 606–60 Bloomberg Barclays US Aggregate (Bond) Index, pricing in, 621 56, 606, 607e, 608, 701, 702, 702e primary, 57, 58–62 Bloomberg Barclays US Aggregate Index, 691, secondary, 57, 62–64 692, 865 Bond portfolios Bloomberg Barclays US Corporate Index, 606, active management of, 351–354 607e, 857 convexity of, 729 Bloomberg Barclays US Corporate High-Yield duration of, 230–232 Index, 606, 607e, 608 interest rate immunization in, 649–650, 650e Bloomberg Barclays US Credit Index, 832 laddered, 609, 644, 704–706, 705e Bloomberg Barclays US High Yield Bond prices, 94–105 Index, 843 characteristics and, 100–104, 101e, 102e, 104e Bloomberg Barclays US TIPS, 606, 607e market discount rate and, 94–96, 101 Bloomberg Barclays US Treasury Bond 10-Year par value and, 6, 95, 103 Term, 606, 607e spot rates and, 104–105 Bloomberg Emerging Market Sovereign Bond yield-to-maturity and, 98–99 Index, 751 Bonds. See also Debt securities; Fixed-income Bloomberg Electronic Trading securities; and specifi c bonds, for example, platform, 63 Zero-coupon bonds Bloomberg Fixed Income Relative Value (FIRV), amortizing, 23–24, 24e 140, 141e basic features of, 8e Bloomberg Yield and Spread (YAS) Analysis, bearer, 19 222–223, 223e, 237–238, 237e cash fl ows of, 23–34 BofA Merrill Lynch US High Yield Master II contingency provisions of, 34–40 Index, 832 conventional, 6–7 Bond analytics, 492–493 coupon payment structures for, 28–33 . See Convexity coupon rate and frequency of, 6–7 Bond covenants currency denominations of, 7–8 affi rmative, 15, 295–296 defi ned, 4 bond indentures and, 11, 15–16 elements of, 4 defi ned, 10 estate puts and, 438–439 negative, 15–16 features of, 5–9 , 465–466 global, 19, 713 Bond equivalent yield, 128 index-linked, 30–33

bindex 897 24 August 2019 10:07 AM 898 Index

Bonds (continued ) defi ned, 437 investment-grade vs. non-investment-grade, 5–6 interest rate volatility and, 446–454, 447e, legal and regulatory considerations with, 18–21 449e, 451e, 453e maturity date of, 6 as liabilities, 646 money duration of, 233–235 lockout period in, 437, 438 overview of, 4–10 risky, 459–462, 460e, 461e, 462e par value of, 6, 95, 103 scenario analysis of bonds with, 464, 464e plain vanilla, 6–7, 8e sell convexity strategy for, 732 principal of, 6 straight bonds vs., 437 principal repayment structures with, 23–33 valuation and analysis of, 441–464 perpetual, 6, 226 valuation at zero volatility, 444, 444e registered, 19 Call exposure enhancements, 697 risky, 526–542 Call options, 437–438, 440 sovereign, 65–67 Call protection, 120, 183–184 supranational, 69–70 Call protection period, 35, 120 swap rates for valuing, 356–357 Call provisions, 26–27 tax considerations with, 21–22 Canada, 271 tenor of, 6, 139 bonds in, 19, 32, 438, 609 use of term, 4 mortgages in, 166, 169 value of, at interest tree nodes, 408, 408e public auction process in, 60 yield measures for, 10 Capacity, 280, 281–295, 818 Bond structure, 839 Capital, in , 818 Bonos del Estrado, 65 Capital bank funds, 83 , 345–346 Capital gains and losses, 21, 22, 132, 204, Bottom-up approach, 832–842, 850–851 207, 210 Bps. Seee Basis points Capital gains tax, 41, 54, 319, 633–634 Brady bonds, 56 Capital-indexed bonds, 32 Bridge fi nancing, 71–72 Capital market securities, 6, 66 British Bankers’ Association (BBA), 52 Capital protected instruments, 79 British Telecom, 29, 303–304, 303e–304e Capital structure, 264–264 BRRD (Bank Recovery and Resolution Capped fl oaters (fl oating-rate bonds), 475–476, Directive), European Union, 558 476e Bulldog bonds, 19 Capped FRNs, 28 Bullet bonds, 23–25, 24e, 41, 830 Carried back, 633 Bullet mortgages, 166 Carried forward, 633 Bullet portfolio, 704, 742–746, 743e–744e, 745e, Carrying value, 207 752–755, 753e–755e, 788–789, 788e, 789e, Carry trades, 732–736, 733e 791e Cash, holding, in portfolio construction, 842 Bull fl attener, 656 Cash collateral accounts, 15, 158 Bull steepener, 656 Cash fl ow matching Bunds, 6, 65, 66, 299, 360, 701, 822, 853 liability-driven investing and, 661–662, 662e Butterfl y movement in yield curves, 799, 799e portfolio management and, 611, 612–613, Butterfl y spread, 726–727, 727e 612e, 614e Butterfl y trades, 761–763, 762e Cash fl ows Buy and hold strategy, 730–731 of bonds, features determining, 4 Buy convexity strategy, 741–742, 742e credit analysis of, 284–285 Buyers, power of, 281 for plain vanilla bonds, 8e portfolio management and, 608–609 C of residential mortgage-backed securities, Callable bonds, 34–35, 120, 229, 229e 172–174, 173e call features of, 437 Cash fl ow yield, 231 convexity of, 473 Cash holdings, 287

bindex 898 24 August 2019 10:07 AM Index 899

Cash-in-advance constraint, 662 residential mortgage-backed securities and, Cash settlement, 63–64, 575 175–180, 177e, 179e, 180e CBOs (collateralized bond obligations), 191 sequential-pay tranches and, 176–178, 177e CCR (corporate credit rating), 273 support tranches and, 178–179, 179e, 180e CDOs. See Collateralized debt obligations Collateral manager, 192 CDs (certifi cates of deposit), 83–84, 569, Collateral trust bonds, 13 570, 571 Commercial mortgage-backed securities CDS. See Credit default swaps (CMBSs), 182–187. See also Mortgage- CDS spread, 573 backed securities (MBS) CDX index, 577, 857 balloon maturity provisions of, 184 Cell approach, 696 call protection and, 183–184 Central bank funds market, 83 credit risk and, 183 Central bank funds rates, 83 international credit portfolios and, 864, 865e Central banks, 56 structure of, 183–184 Certifi cates of deposit (CDs), 83–84, 569, (CP), 71–74 570, 571 characteristics of, 71–72 CFR (corporate family rating), 273 credit quality of, 72–73, 72e Change of control covenant, 296n27 defi ned, 71 Change of control put, 313 US vs. Eurocommercial, 73–74, 73e, 74e Character, in credit analysis, 281, 296–297, 818 Committed bank lines, 287 Cheapest-to-deliver (CTD) security, 571, 671 Commodity Futures Trading Commission Checking accounts, 82 (CFTC), 701 Chicago Board Options Exchange, 701 Companies, as bond issuers, 5 Chicago Mercantile Exchange (CME), 679, 700 Competitive position, 283 CIA World Fact Book, 356 Competitors, rivalry among, 282 CIR (Cox–Ingersoll–Ross) model, 370–372, Conditional prepayment rate (CPR), 171 372e, 373 Conditional probabilities of default, 511 Citigroup bond index, 692 Condor trades, 763, 763e Claims, priority of, 265, 268–269 Consols, 6, 65, 226 Clearstream, 63–64, 77 Constant-yield price trajectory, 104, 104e, 207, CLNs (credit-linked notes), 79–80 207e CLOs (collateralized loan obligations), 191, 866 Consumer Price Index (CPI), 30–31, 32 CMBSs. See Commercial mortgage-backed Consumer Price Index for All Urban Consumers securities (CPI-U), 67 CME Group, 360, 670, 671, 673, 701 Contingency provisions, 34–39 CMOs. See Collateralized mortgage obligations callable bonds and, 34–35 CoCos (contingent convertible bonds), 39 convertible bonds and, 37–39 Collared FRNs, 28 corporate notes and bonds and, 76–77 Collateral, 10 defi ned, 34 credit analysis and, 280, 281, 295, 818 putable bonds and, 36–37 Collateral backing, 11, 12–14, 76 Contingent claims, 570 Collateralized bond obligations (CBOs), 191 Contingent convertible bonds (CoCos), 39, 487 Collateralized debt obligations (CDOs), 99, Contingent immunization, 614, 661, 674 191–194 Contingent puts, 477 international credit portfolios with, 865–866 Contraction risk, 171 synthetic, 596 Contract rate, 165 Collateralized loan obligations (CLOs), 191, 866 Control put, change of, 313 Collateralized mortgage obligations (CMOs) Conventional bonds, 6–7 fl oating-rate tranches and, 180 Conversion, forced, 483 mortgage pass-through securities vs., 176 Conversion parity, 38 planned amortization class tranches and, Conversion period, 481 178–179, 179e, 180e Conversion premium, 38

bindex 899 24 August 2019 10:07 AM 900 Index

Conversion price, 38, 481 deferred, 30, 75 Conversion ratio, 38, 482 payment-in-kind, 29–30 Conversion value, 38, 484 as sovereign bonds, 67 Convertible bonds, 37–39, 77 split, 30 analysis of, 483–486 step-up, 29 call provision of, 438 Coupon eff ect, 102 defi ned, 481 Coupon payments, 6 downside risk with, 486 Coupon payment structures in, 438 bonds and, 28–33 minimum value of, 484–485 of corporate notes and bonds, 75 risk-return characteristics of, 488–490, 489e credit-linked coupon bonds and, 29 upside potential of, 486 deferred coupon bonds and, 30 valuation of, 487–492, 481e–482e index-linked bonds and, 30–33 Convertible mortgages, 166 payment-in-kind coupon bonds and, 29–30 Convexity step-up coupon bonds and, 29 of bonds, 235–245, 236e Coupon rate, 6–7 defi ned, 728 Coupons eff ective, 472–473 calculation of, 6 of laddered portfolio, 705 defi ned, 6 Convexity adjustment, 236 fi xed-income markets classifi ed by type of, Convexity eff ect, 100, 101, 102e, 245 50–53 Corporate bonds, 74–77 Covenant Review, 296 asset or collateral backing for, 76 Covenants as callable bonds, 437 affi rmative, 15, 295–296 contingency provisions of, 76–77 bond indentures and, 11, 15–16 coupon payment structures of, 75 credit analysis and, 281, 295–296, 313–314, credit loss rate for, 818–819, 818e–819e 818 investment-grade vs. high-yield, 818 defi ned, 10 issuance, trading, and settlement of, 77 negative, 15–16 legal issuer of, 11 Coverage ratios, 286 maturities of, 74–75 Covered bonds, 13–14, 558, 867 principal repayment structures of, 75–76 Cover pool, 13–14, 867 repayment sources for, 12 Cox–Ingersoll–Ross (CIR) model, 370–372, settlement of, 63–64 372e, 373 Corporate credit rating (CCR), 273 CPI (Consumer Price Index), 30–31, 32 Corporate debt, 70–79 CPI-U (Consumer Price Index for All Urban bank loans and, 71 Consumers), 67 commercial paper and, 71–74 CPR (conditional prepayment rate), 171–172 notes and bonds and, 74–77 Creation units, 699 syndicated loans and, 62 Credit analysis, 261–324 Corporate debt securities, 279–307 capacity and, 281–295, 818 Corporate family rating (CFR), 273 capital and, 818 Corporate notes, 74–77 capital structure and, 264–264 asset or collateral backing for, 76 character and, 296–297, 818 contingency provisions of, 76–77 collateral and, 295, 818 coupon payment structures of, 75 corporate debt securities and, 279–307 issuance, trading, and settlement of, 77 covenants and, 295–296, 818 maturities of, 74–75 credit curves and, 305–306, 306e principal repayment structures of, 75–76 credit ratings and, 271–273, 272e Country exposure, 849 credit risk and, 262–263 Coupon bonds default risk and, 304–305, 305e credit-linked, 29 equity analysis vs., 280

bindex 900 24 August 2019 10:07 AM Index 901

fi ve Cs of, 818 succession event and, 575 four Cs of, 280–281, 818 types of, 571–572 goal of, 279 valuation changes in, 587–588 high-yield bonds and, 307–315, 312e, 314e Credit derivatives, 569–57 industry and company analysis in, 280–283 Credit duration, 251 issuer vs. issuer ratings in, 273–274 Credit enhancements, 62, 169 non-sovereign debt and, 319–321, 320e auto loan–backed securities with, 188 recovery rates and, 267–269, 267e, 268e bond indentures and, 11, 14–15 rating agencies, role of, 270–271 credit agency evaluation of, 182 ratios and ratio analysis in, 284–286, 287e securitizations and, 158 risks in relying on agency ratings in, 274–276, types of, 14 275e, 276e Credit event, 574–575 seniority ranking and, 264–266, 264e Credit exposures, 590–591 sovereign debt and, 315–317 Credit-linked coupon bonds, 29 yield spreads and, 298–307, 298e, 299e, 301e Credit-linked notes (CLNs), 79–80, 569 price impacts and, 302–304, 303e–304e Credit loss rate, 818–819, 818e–819e Credit analysis models, 507–559 Credit markets credit risk measures and, 508–516, 510e, 513e secondary, liquidity in, 853–856, 854e, 855e credit scores and credit ratings and, 517–522, trading volume on, 854 518e, 519e, 521e Credit migration risk, 263, 522, 819–820, 834 credit spread changes and, 542–547 Credit portfolios, 817–869 credit value adjustment (CVA) and, 510–512, agency ratings and, 818 510e, 543–544, 543e bond dealers and inventory size and, 825 reduced form, 522–526 bottom-up approach in, 832–842, 850–851 risky bonds in arbitrage-free framework, credit loss rate and, 818–819, 818e–819e 526–542 credit migration risk and spread risk and, securitized debt and, 554–558, 555e–556e 819–820 structural, 522–526 credit quality in, 842–845, 843e term structure of credit spreads and, 548–554, credit risk and, 819–820, 819e–820e 552e–553e credit spreads and, 830–832 traditional, 549–550, 578 credit strategies approaches in, 832–852 Credit card asset-backed securities (ABS), environmental, social, and governance (ESG) 190–191 factors in, 851–852 Credit card debt, 5, 154, 865 establishing universe of eligible bonds and Credit correlation, 572 dividing into sectors in, 833 Credit curves, 305–306, 306e fi ve Cs of credit analysis in, 818 credit default swaps and, 584–585 global liquidity considerations in, 862 Credit cycles, 268, 300, 860 interest rates–credit spreads relationship in, 824 Credit default swaps (CDS), 569–596, 838 interest rate risk and, 821–824, 822e, 823e, applications of, 589–596 824e credit curve and, 584–585 international, 859–863 credit event and, 574–575 liquidity and trading and, 824–825 credit portfolios and, 857 liquidity risk and, 853–857 defi ned, 570–571 option-adjusted spread and, 823, 823e index products and, 577 quoting practices diff erences in, 825 market characteristics of, 578–580 relative value analysis in, 834–835 market features and, 572–573 sector classifi cations used in, 833 monetizing gains and losses in, 589–590 spread curves in, 837–838, 838e, 850, 850e payment structure of, 571, 571e spread duration and, 819 pricing conventions for, 585–586 structured fi nancial instruments in, 863–867 pricing of, 581–584, 582e tail risk in, 857–859 settlement protocols for, 575–576 top-down approach in, 842–852

bindex 901 24 August 2019 10:07 AM 902 Index

Credit protection buyer, 570 Credit scores, 517–522, 518e, 519e, 521e Credit protection seller, 570 Credit spreads, 508 Credit quality credit analysis models of changes in, 542–547 of commercial paper, 72–73, 72e credit portfolios and, 824, 830–832, 842 in credit portfolios, 842–845, 843e credit risk model and, 508, 512–514 emerging market credit and, 862 measures of, 826–830 of fi xed-income markets, 49–50 over swap rates, 551e of sovereign bonds, 67 term structure of, 113, 161–162 Credit rating agencies, 5, 518, 818. See also Fitch Credit strategy, 832 Ratings; Moody’s Investors Service; Standard Credit Support Annex (CSA), 687 & Poor’s Credit tranching, 14, 160–161, 866 historical default rate information from, 834 Credit value adjustment (CVA), 510–512 510e, notching by, 273–274 543–544, 543e risks in relying on ratings from, 274–276, Cross-default provisions, 273 275e, 276e Crowding risk, 736 role of, 270–271 CSA (Credit Support Annex), 687 sovereign ratings from, 66 C-spread, 139 Credit ratings, 271–273, 272e Currency denominations changes over time in, 275–276, 277e of bonds, 7–8 credit portfolio and, 818, 844–845, 844e of fi xed-income markets, 50, 50e credit risk analysis and, 517–522, 518e, Currency exposure, 849 519e, 521e Currency option bonds, 8 market’s pricing of credit risk and lag in, Currency risk, 862–863 276–277, 277e , 10, 118 of non-sovereign bonds, 69 Curvature movement, 379 rating agencies providing, 161, 271–273, Curve duration, 213, 220, 223 272e, 518 Curve trades, 593 risks in relying on, 274–276, 275e, 276e Cushion, 35 securitization and, 161, 162 Customers, power of, 281 Credit risk, 262–263 Cyclical industries, 282 bond duration and convexity and, 251–252 bond issuers and, 5 D collateral backing and, 12 DBRS (Dominion Bond Rating Service), 271 commercial mortgage-backed securities Death-puts bonds, 439 and, 183 , 13 components of, 818 Debt credit agency ratings lag in market’s pricing, credit analysis and, 261–262, 288 276–277, 277e high-yield companies and, 309–311 credit default swaps and, 578 restrictions on, 15 credit portfolio and, 819–820, 819e–820e, 834 Debt/capital ratio, 286 default risk vs., 508 Debt/EBITDA ratio, 286 high-yield bond portfolios and, 823 Debt securities. See also Bonds; Fixed-income relative value analysis of, 834–835 securities repurchase agreements and, 85–86 use of term, 4 non-agency residential mortgage-backed Debt service coverage ratio (DSCR), 183 securities and, 182 Debt-to-service-coverage (DSC) ratio, 183, 321 projected cash fl ows and, 509, 509e Decomposing expected fi xed-income returns, sinking fund bonds and, 439 623–624, 627 Credit risk measures Default for credit analysis models, 508–510, 510e, 513e probability of (POD), 262, 509, 511, 544–545, in credit portfolios, 953 544e, 581, 582e Credit Roundtable, 296 structural model of, 523–525, 524e

bindex 902 24 August 2019 10:07 AM Index 903

Default correlations, 866 DSCR (debt service coverage ration), 183 Default-free bonds, 442–443, 442e Duration Default interest rate, 184 bond portfolios and, 230–232 Default probability, 262, 509, 511, 544–545, bonds with embedded options and, 465–472 544e, 581, 582e derivatives for altering, 738–741 Default rates, 274, 275e eff ective. See Eff ective duration Default risk, 262, 273, 648 key rate, 470–472, 470e–472e credit analysis and, 304–305, 305e one-sided, 469–470, 469e, 470e credit portfolios and, 818, 834 yield curve measures of, 727–728 credit default swaps and, 578 yield curve strategies using, 737–746, 738e credit risk vs., 508 Duration management, 737–746, 738e relative value analysis of, 834–835 Duration matching Deferred coupon bonds, 30, 75 liability-driven investing and, 661, 664–668, Defi ned benefi t pension plans, 644, 645, 647, 665e, 666e, 667e 675–683, 676e, 680e portfolio management and, 611, 613–615, 614e Delivery option, 440 Duration positioning, 748–752, 748e, 749e, 751e Demand deposits, 82 Duration times spread (DTS), 845 Depository Trust and Clearinghouse Corporation, 579 E Derivatives Early amortization, 190 credit portfolios and, 849 Early repayment option, 167 portfolio duration and, 738–741 Earnings before interest, taxes, depreciation, and Derivatives overlay, 661, 670–673, 671e–672e, amortization (EBITDA), 285, 847 681–683 EBITDA (earnings before interest, taxes, Deutsche Bank indexes, 861 depreciation, and amortization), 285, 847 DIC Asset AG, 438 EBITDA/interest expense ratio, 286 Discount, issue at, 21, 22e EBIT/interest expense ratio, 286 Discount factor, 336, 512 ECP (Eurocommercial paper), 73–74, 73e, 74e Discount function, 336 Eff ective annual rate, 115 Discount margin, 122, 537–539, 538e Eff ective convexity, 244, 472–473 Discount rates, 25 Eff ective duration, 220–224, 223e, 728–729 money market instruments, 125 bonds with embedded options and, 465–469, Monte Carlo method and, 424e 466e–468e Dispersion, 652 credit portfolios and, 822, 822e Distributions, restrictions on, 16 defi ned, 465, 727–728 Diversifi cation Electronic Municipal Market Access (EMMA), credit portfolios and, 859 621 fi xed-income portfolio and, 606–608, 607e Embedded options, 34, 436–495 Dollar duration. See Money duration bond analytics and, 492–493 Domestic bond portfolio, 640–641 both callable and putable, 438 Domestic bonds, 18–19, 53, 315, 317, 773 call options and, 437–438. See also Callable Dominion Bond Rating Service (DBRS), 271 bonds Dow Jones Industrial Average, 690 complex, 438–439 Downgrade risk, 263 defi ned, 436 Drift term extension options and, 438. See also Extendible in arbitrage-free models, 374 bonds in Cox–Ingersoll–Ross model, 371 interest rate risk and, 465–473, 466e, 467e, in Ho–Lee model, 374 468e in Monte Carlo method, 423 overview of, 436–441 in , 372, 373 put options and, 438. See also Putable bonds DSC (debt-to-service-coverage) ratio, scenario analysis of bonds with, 463–464, 464e 183, 321 simple, 437–438

bindex 903 24 August 2019 10:07 AM 904 Index

Embedded options (continued ) Exchange-traded funds (ETFs), 56, 622, valuation and analysis of bonds with, 435–495 698–701, 706, 857 valuation and analysis of callable and putable Expectations theory, 364–365 bonds with, 441–464 Expected exposure, 508–509 valuation and analysis of capped and fl oored Expected loss, 263, 582 fl oating-rate bonds and, 475–480, 476e, Experian, 517 478e Extendible bond, 438, 456 valuation and analysis of convertible bonds and, Extension risk, 171 480–492, 481e–482e External credit enhancements, 14, 158 yield measures and, 120 EMBI (J.P. Morgan Emerging Market Bond F Index) Global, 56 Face value, 6 Emerging markets Failure to pay, 575 debt and equity outstanding in, 49, 50e Fair Isaac Corporation, 517 as fi xed-income markets, 53, 56 Fannie Mae (Federal National Mortgage sovereign bonds issued in, 66, 67 Association), 28, 52, 69, 169, 182, 195, Emerging market credit, 861–862 437, 769, 864 EMMA (Electronic Municipal Market Access), Federal Farm Credit Banks, 437 621 Federal Home Loan Banks (FHLBs), 28, Empirical duration, 822, 822e 69, 437 Enhanced indexing, 616–617, 617e Federal Home Loan Mortgage Corporation Enhanced indexing strategy, 690 (Freddie Mac), 28, 69, 169, 182, 195, 437, Entry, threat of, 281 864 Environmental, social, and governance (ESG) Federal National Mortgage Association (Fannie factors, 611, 696, 851–852 Mae), 28, 52, 69, 169, 182, 195, 437, 769, Eonia (Euro OverNight Index Average), 364 864 Equifax, 517 Federal Reserve (Fed), 52, 83, 824 Equilibrium term structure models, 369–376 Federal Reserve Bank of New York (New York Equipment trust certifi cates, 13 Fed), 62 Equity analysis, 280 Fed funds, 83 Equity tranches, 183, 192, 194, 866 Fed funds rates, 83 ESG (environmental, social, and governance) FCF. See Free cash fl ow factors, 611, 696, 851–852 FCF after dividends/debt ratio, 286 Estate puts, 438–439 FFO (funds from operations), 285 ETFs (exchange-traded funds), 56, 622, FFO/debt ratio, 286 698–701, 706, 857 FHLBs (Federal Home Loan Banks), 28, 69, 437 Eurex, 700 FICO score, 517, 517e Euribor (Euro interbank off ered rate), 7, 28, 32, Fideicomiso Financiero Autos VI, 188 52, 125, 355 Financial Industry Regulatory Authority market, 18, 19, 20, 41, 53, 63, 84, 88 (FINRA), 621, 692 Eurobonds, 19–20, 28, 53 Financial market performance, 300 Euroclear, 63–64, 77 FINRA (Financial Industry Regulatory Eurocommercial paper (ECP), 73–74, 73e, 74e Authority), 621, 692 Euro interbank off ered rate (Euribor), 7, 28, 32, Firm commitment off erings, 59 52, 125, 355 First lien debt, 265–266 Euro OverNight Index Average (Eonia), 364 First-loss piece, 183 European Model Covenant Initiative, 296 First mortgage debt, 265 European-style calls, 35, 437 Fitch Ratings, 5n2, 270–271 European-style putable bonds, 438 bond ratings by, 48 European Union, 56, 315, 558, 863 credit ratings by, 161, 271–273, 272e, 518 Evaluated pricing, 692 notching by, 273–274 Excess returns, 831, 845–846 sovereign ratings by, 66

bindex 904 24 August 2019 10:07 AM Index 905

Fixed-income bonds. See also Fixed-income Flight to quality, 252, 608, 723 securities Floaters. See Floating-rate notes interest rate immunization with, 648–649, Floating-rate bonds, 50, 67, 476 649e, Floating-rate debt, 51 Fixed-income indexes, 55–56 Floating-rate notes (FRNs, fl oaters), 27–29, Fixed-income markets, 47–57 50–51, 121 about, 47–48 capped, 475–476, 476e classifi cation of, 48–54 components of coupon rate of, 5, 7 coupon type, classifi cation by, 50–53 credit risk analysis of, 534–538, 535e, 537e, credit quality, classifi cation by, 49–50 537e currency denomination, classifi cation by, inverse, 28–29, 80–81, 180, 630, 801 50, 50e as participation instrument, 80 geography, classifi cation by, 53–54 payment structures of, 75 indexes for, 55–56 quoted margin on, 121 investors in, 56–57 reference rates for, 7, 28, 32, 42, 50–51, 71 issuer type, classifi cation by, 5, 48–49, 49e reverse, 28–29 maturity, classifi cation by, 50 risky, 534–536, 535e Fixed-income portfolio management. See yield measures for, 121–124 Portfolio management Floating-rate tranches, 180 Fixed-income securities, 3–42. See also Bonds; Floored fl oaters (fl oating-rate bonds), 479–480, Debt securities 478e arbitrage-free valuation framework and, Floored FRNs, 28 400–401 Forced conversion, 483 investors in, 56–57 Ford Motor Company, 276, 277e legal and regulatory considerations with, Foreclosures, 164 18–21 lender’s rights in, 167 maturity date of, 6 Foreign bond markets, 53 overview of, 4–10 Foreign bonds, 18–19, 53, 217 portfolio management roles of, 3–4, 606–610. Forward curves, 337, 722 See also Portfolio management spot curves vs., 342–344, 343e, 344e, use of term, 4 351–353 Fixed-income valuation, 93–145 yield curves and, 349–354 future cash fl ows and, 94–105 Forward pricing model, 337 matrix pricing and, 111–113, 112e Forward rate, 337, 339–341 maturity structure of interest rates and, Forward rate model, 338–346, 343e, 344e 130–138, 131e, 132e, 134e France, 5, 65, 67 price paid vs. quoted price and, 107–109 Freddie Mac (Federal Home Loan measures and, 114–130 Corporation), 28, 69, 169, 182, 195, 437, yield spreads and, 138–142, 139e, 141e 864 yield-to-maturity and, 98–99 Free cash fl ow after dividends (FCF after Fixed-rate bonds dividends), 285 credit and liquidity risk and, 251–252 Free cash fl ow before dividends (FCF after interest rate risk on, 212–245 dividends), 285 investment horizon and, 245–250 French consumer price index (CPI), 67 pricing of, 94–105 FRNs. See Floating-rate notes risk and return on, 203–255 FTSE Index Series, 56 sources of return on, 204–211 Full price, 107–109 as sovereign bonds, 67 Full replication approach, 690 yield measures for, 118–121 Fully amortized bonds, 23–25, 24e Fixed-rate debt, 50 Funding valuation adjustment (FVA), 543 Fixed-rate mortgages, 165 Funds from operations (FFO), 285 Flat price, 107–109 Futures contracts, 629

bindex 905 24 August 2019 10:07 AM 906 Index

G Harmonized Index of Consumer Prices (HICP), 67 GDP growth rate, 842–844, 843e Hazard rate, 581 GE Capital Corporation, 191, 361, 438 Hedges, tail risk, 859 General obligation (GO) bonds, 319 Hedging ratio, 680 Geography, classifi cation of fi xed income markets Hibor (Hong Kong interbank off ered rate), 7, 52 by, 53–54 HICP (Harmonized Index of Consumer Germany Prices), 67 in, 867 High-yield bonds, 5, 50 Eurocommercial paper in, 74e credit loss rate for, 821 fl oating-rate bonds in, 67 credit risk and, 823 government bonds (Bunds) in, 6, 65, 66, 299, historical returns on, 314, 314e 360, 701, 822, 853 investment-grade bonds vs., 818 infl ation-linked bonds in, 31 liquidity and trading and, 825 sovereign rating of, 66 option-adjusted spread of, 823–824, 824e Gilts, 6, 11, 65, 701 quoting practices diff erences and, 825 as benchmark in United Kingdom, 360, rating categories of, 271–272, 272e 401, 437 spread risk and default risk and, 821 repurchase agreements with, 84–85 High-yield companies, 307–315, 312e, 314e Ginnie Mae (Government National Mortgage Holding companies, 11 Association), 169, 182, 195, 270n9, 864 Ho–Lee model, 374–375 Global bond markets, 18, 620, 622, 692 Hong Kong interbank off ered rate (Hibor), 7, 52 Global bond portfolio, 640, 641e, 823–824, 824e Hong Kong stock market, 690 Global bonds, 19, 713 Horizon matching, 614 Global fi nancial instruments, 690–691 Horizon yield, 207 Global McKinsey Institute, 690 Hydro Quebec, 69 Goldman Sachs, 6 Government bonds I callable features of, 437–438 ICE (International Currency Exchange), 62 yield curves for, 132e, 140 ICMA (International Capital Market Government equivalent yield, 118 Association), 63 Government gilts, 6, 11, 30, 54, 65 IMF (International Monetary Fund), 69, 315 as benchmark in United Kingdom, 360, Immunization 401, 437 contingent, 614, 661, 674 repurchase agreements with, 84–85 defi ned, 648 Government National Mortgage Association liability-driven investing and, 648–659, 649e, (Ginnie Mae), 169, 182, 195, 270n9, 864 650e–651e, 653e, 656e, 657e, 658e Governments, as bond issuers, 5, 12, 19 portfolio management with, 611, 612, 613, 614 Government-sponsored enterprises (GSEs), 28, Index credit default swaps (CDSs), 571, 572 69, 169, 182, 195, 437 Indexed-annuity bonds, 32 Grey market, 59 Indexing, 842 Growth industries, 282 Index-linked bonds, 30–32, 32e–33e GSEs (government-sponsored enterprises), 28, Index-referenced adjustable-rate mortgages 69, 169, 182, 195, 437 (ARMs), 166 G-spreads, 139, 140, 508, 826–827, 829, 830, Industry analysis 872. See also Credit spread fundamentals in, 282–283 Guarantee certifi cates, 79 structure in, 281–282 Guideline constraints, in credit portfolios, 852 Industry sector allocation, 846–847, 847e Infl ation, portfolio hedging against, 609, 609e H Infl ation duration, 251 Haircut, 86 Infl ation-indexed bonds, 646 Hang Seng Index, 690 Infl ation-linked bonds (linkers), 30–31, 31e, Hard put options, 483 53, 609

bindex 906 24 August 2019 10:07 AM Index 907

Infor, 312, 312e callable and putable bonds with, 446–454, Initial-period-fi xed-rate mortgages, 166 447e–451e, 453e Institutional investors, 13, 56 default-free callable and putable bonds and, In-substance defeasance, 661 451–456, 452e, 453e, 455e Intensity-based credit analysis model, 523 interest rate tree for, 447, 447e Interbank funds, 83–84 mortgage-backed securities and, 864 Interbank money market (interbank market), 51 option-adjusted spread and, 461–462, 462e Intercontinental Exchange, 700 Inter-market yield curve strategies, 770–784 Interest-indexed bonds, 32 Internal credit enhancements, 14, 158, 160 Interest-only lifetime mortgages, 166 International Capital Market Association Interest-only mortgages, 166 (ICMA), 63 Interest rate exposure, 848–849 International credit portfolios, 859–863 Interest rate immunization International Currency Exchange (ICE), 52 defi ned, 648 International debt issuers, 20e interest rate risk and, 657–658, 660–674 International Monetary Fund (IMF), process of, 648–659, 649e, 650e–651e, 653e, 69, 315 656e, 657e, 658e International Swaps and Derivatives Association Interest rate measurement, 848 (ISDA), 572, 575, 599, 687, 700 Interest rate risk Interpolated spread (I-spread), 140, 360n6, bond duration properties and, 224–245 362, 872 bonds with embedded options and, 465–473, Inverse fl oating-rate notes (FRNs, fl oaters), 466e, 467e 28–29, 80–81, 180, 630, 801 credit default swaps and, 578 Investment-grade bonds, 49 credit portfolios and, 821–824, 822e, 823e, high-yield bonds vs., 818 824, 824e interest rate sensitivity of, 823 eff ective duration and, 220–224, 223e liquidity and trading and, 825 fi xed-rate bonds and, 212–245 non-investment-grade bonds vs., 5–6 interest rate immunization and, 657–658, option-adjusted spread of, 823–824, 824e 660–674 quoting practices diff erences and, 825 investment horizon and, 245–250 rating categories of, 271–272, 272e key rate duration and, 224–225 spread risk and default risk and, 821 Macaulay duration and, 213–216, 214e, 215e, Investment horizon, 210–211, 245–250 219, 224–225, 225e, 247–250, 249e Investment vehicles, 634 modifi ed duration and, 217–219, 218e, 224 Investors Interest rates central banks as, 56 maturity structure of, 130–138, 132e, 135e in fi xed-income markets, 56–57 realized rates of return and changes in, in fi xed-income securities, 56–57 205–206 fl ight to quality by, 252, 608, 723 residential mortgage loans and, 165–166 institutional, 56 step-up coupons and, 29 retail, 56 Interest rate sensitivity, 822, 823 ISDA (International Swaps and Derivatives Interest rate swaps, 629, 679–680, 680e, Association), 572, 575, 599, 687, 700 686–687, 743 ISDA Master Agreement, 572, 700 Interest rate trees I-spread (interpolated spread), 140, 872, binomial, 403–407, 404e, 405e, 407e, 828–829, 830, 828e 410–414, 410e–414e, 451, 452e Issuance, 77 eff ect of interest rate volatility on, Issuance date, 839 447, 447e Issue credit rating, 273 option-adjusted spread and, 460e Issuer credit rating, 273 Interest rate volatility Issuer exposure, 693 arbitrage-free valuation framework and, Issuer liquidity, 287–288 401–403 Issuer ratings, 273–274

bindex 907 24 August 2019 10:07 AM 908 Index

Issuers LBOs (leveraged buyouts), 30, 296, 315 of bonds, 5–6, 10 Legal considerations, 18–21 fi xed-income markets classifi ed by type of, 5, Legal identity of bond issuers, 11–12 48–49, 49e Legal risk, in global markets, 863 issuer ratings vs., 273–274 Lehman Aggregate Bond Index, 56 legal identity of, 11–12 Lehman Brothers, 83, 309, 523 Issue selection enhancements, 696 Letras del Tesoro, 65 Issue size, 839 Letters of credit, 15 iTraxx, 577 Level movement, 379 Leverage, in portfolio management, 628–632 J Leveraged buyouts (LBOs), 30, 296, 315 Japan, 19, 21 Leveraged instruments, 80–81 callable bonds in, 438 Leverage ratios, 286 carry trades in, 736–737 Liability-based investing. See Liability-driven debt and equity outstanding in, 49, 50e investing sovereign bonds in, 67 Liability-based mandates, 611–613 yield curve movement in, 289, 390e Liability-driven investing (LDI), 611, 644–648 Japan Bank for International Cooperation asset-liability management strategies in, (JBIC), 69 644, 645 Japan Credit Rating Agency (JCR), 271 benchmark selection in, 701–703, 702e Japanese government bonds (JGBs), 8, 65, bond indexes in, 689–690 66, 118 cash fl ow matching and, 661–662, 662e Japan Housing Finance Agency (JHF), 169 classifi cation of liabilities in, 645–647, 646e JBIC (Japan Bank for International contingent immunization and, 661, 674 Cooperation), 69 defi ned benefi t pension plan and, 675–683, JCR (Japan Credit Rating Agency), 271 676e, 680e JGBs (Japanese government bonds), 8, 65, derivatives overlay and, 661, 670–673, 66, 118 671e–672e JHF (Japan Housing Finance Agency), 169 duration matching and, 661, 664–668, 665e, J.P. Morgan Emerging Market Bond Index 666e, 667e (EMBI) Global, 56 interest rate immunization in, 648–659, 649e, JP Morgan Index–Emerging 650e–651e, 653e, 656e, 657e, 658e Markets Global (GBI–EM Global), 607, interest rate swaps in, 679–680, 680e, 686–687 607e, 608 risks in, 685–688 Junk bonds, 49, 271–272, 272e Libor. See London interbank off ered rate Libor–OIS spread, 364 K Lien debt, 265–266 Kangaroo bonds, 19 Liens, limitations on, 313 Key rate duration, 470–472, 470e–472e, Limitations on liens, 313 692–693, 728, 848 Linkers (infl ation-linked bonds), 30–31, 31e, 53 Kimchi bonds, 19 Liquidation, priority of claims in, 268–269 Korea. See South Korea Liquidity Korea interbank off ered rate (Koribor), 52 bond dealers and inventory size and, 825 Kuwait, 50 bond markets and, 619–622 credit portfolios and, 824–825 L global considerations in, 862 Laddered bond portfolios, 609, 644, 704–706, high-yield companies and, 308–309 705e, 787–788, 787e, 788e, 789–790, residential mortgage-backed securities and, 864 789e–791e secondary bond markets and, 63 Large-denomination negotiable certifi cates of secondary credit markets and, 853–856, deposit (CDs), 84 854e, 855e Law of one price, 399 Liquidity duration, 251

bindex 908 24 August 2019 10:07 AM Index 909

Liquidity enhancements, 72 Maturity structure Liquidity preference theory, 365–366 of interest rates, 130–138, 132e, 135e Liquidity premiums, 365 of yield curve volatilities, 382, 382e Liquidity risk, 251–252, 834, 853–857 Maturity value, 6 Liquidity valuation adjustment (LVA), 543 MBS. See Mortgage-backed securities Loan-to-value ratio (LTV), 165, 183 Medium-term notes (MTNs), 75 Local expectations theory, 364–365 Mibor (Mumbai interbank off ered rate), 52 Lockout period, 35, 437, 438 Modifi ed duration, 217–219, 218e, 224–225, London interbank off ered rate (Libor), 355 727, 728 defi ned, 7 Monetizing, 588 phaseout of, 52 Money convexity, 241 reference rates from, 51–53 Money duration, 233–235, 664–664, 728 Long/short trades, 591 Money market instruments, 125–130 Long straddle, 440 Money market securities, 6, 65 Long-Term Capital Management crisis (1998), Monoline insurance companies, 15, 158 723, 723e Monte Carlo method, 423–424, 543 Loss given default, 262, 509, 582, 818 Moody’s Investors Service, 5n2, 270–271 Loss severity, 262–263, 818 bond ratings by, 5n2, 49 Lower cost enhancements, 696 commercial paper ratings by, 72e LTV (loan-to-value ratio), 165 credit loss rate from, 818–819, 818e–819e credit ratings by, 161, 271–273, 272e, 518 M market’s pricing of credit risk and, 276–277, Macaulay duration, 213–216, 214e, 215e, 277e 219, 224–225, 225e, 247–250, 249e, notching by, 273–274 727, 728 sovereign ratings by, 66 Maintenance covenants, 314 Morgan Stanley, 6 Make-whole calls, 35, 437 Mortgage-backed securities (MBS). See also Make-whole changes, 184 Commercial mortgage-backed securities Management, industry analysis of, 283 (CMBSs); Residential mortgage-backed Maple bonds, 19 securities (RMBS) MarketAxess, 692 defi ned, 154 Market conversion premium per share, 485 interest payments by, 6 Market conversion premium ratio, 486 international credit portfolios with, 863, Market conversion price, 485–486 864–865, 865e Market discount rate, 94–96, 101 quantitative easing (QE) and, 367–368, 367e Market liquidity risk, 263 repayment structure for, 25 Market making, 300 sell convexity strategy for, 732 Market value, 840 Mortgage loans, 164. See also Residential Markit indexes, 577 mortgage loans Matador bonds, 19 Mortgage pass-through securities, 170–174, 173e, Matrix pricing, 111–113, 112e, 692 176 Matryoshka bonds, 19 Mortgage rate, 165 Maturity MSCI World Index, 690 of bonds, 6 MTNs (medium-term notes), 75 of commercial paper, 73 Multiple-price auction, 60 of corporate notes and bonds, 74–75 Mumbai interbank off ered rate (Mibor), 52 fi xed-income markets classifi ed by, 50 Municipal bonds (munis) of government bonds, 437 non-sovereign bonds as, 69, 319 of residential mortgage loans, 165 as tax-exempt bonds, 54, 438 Maturity date, 6 Municipal debt, 320, 320e Maturity eff ect, 102, 226 Municipal Securities Rulemaking Board, 621 Maturity maintenance, 848–849 Mutual funds, 698

bindex 909 24 August 2019 10:07 AM 910 Index

N Option-adjusted spread (OAS) Naked credit default swap, 590 bonds with embedded options and, 459–462, National bond markets, 18 460e, 461e National Highways Authority of India (NHAI), credit analysis and, 301, 301e 54 credit portfolios and, 823–824, 823e, 824e, NAV (net asset value), 698, 699 829, 830, 845 Negative butterfl y, 658 z-spread and, 142 Negative covenants, 15–16 Option-adjusted yield, 121 Negative pledges, 16 Option-free bonds Negotiable certifi cates of deposit (CDs), 83–84 arbitrage-free valuation framework for, Net asset value (NAV), 698, 699 417–418, 418e, 419e Net working capital, 287 valuation of, 442–443, 442e No-arbitrage principle, 337 Options Nominal rate, 6. See also Coupon rate embedded. See Embedded options Nominal value, 6 optimal exercise of, 445 Non-agency residential mortgage-backed valuation of, 492 securities (RMBS), 169, 182 yield curve strategies using, 765–770, Non-cyclical industries, 282 766e–770e Non-investment-grade bonds, 5–6, 49 Organized exchange, 63 rating categories of, 271–272, 272e OTC (over-the-counter) markets, 57, 63 Non-mortgage asset-backed securities, 187–194 Overcollateralization, 14, 158, 182, 188, 557 Non-negotiable certifi cates of deposit (CDs), Overnight funds, 83 83–84 Overnight indexed swap (OIS), 364 Non-recourse loans, 167 Overnight repos, 85 Non-sovereign debt, 319–321, 320e Over-the-counter (OTC) markets, 57, 63 Non-sovereign government bonds (non-sovereign bonds), 68–69 P Notching, 273–274, 274e PAC (planned amortization class) tranches, Note rate, 165 178–179, 179e, 180e Notional amount, 573 Panda bonds, 19 Pan-European Aggregate Bond Index, 56 O Par, pulled to, 205 OAS (option-adjusted spread) Parallel shift, 232, 724 bonds with embedded options and, 459–462, Par curves, 344, 722 460e, 461e Pari passu, 267, 313, 571 commercial mortgage-backed securities Par swaps, 356 (CMBSs) and, 865, 865e Partial duration, 224, 470, 728, 755–756, 809e credit analysis and, 301, 301e Partial equilibrium models, 376 international credit portfolios and, 823–824, Partially amortized bonds, 23–25, 24e 823e, 824e, 829, 830, 845 Participation instruments, 80 z-spread and, 142 Par value (of bond), 6, 95, 103 Obligaciones del Estado, 65 Passive investment, 695 Obligations assimilables du Trésor (OATs), 65 Pass-through rate, 170 Off -the-run securities, 139 Pathwise valuation, 419–421, 420e, 421e Off -the-run series, Markit indexes, 577 Payment-in-kind (PIK) coupon bonds, 29–30, 75 OIS (overnight indexed swap), 364 Payout amount, 576 One-sided duration, 469–470, 469e, 470e Payout ratio, 576 On-the-run securities, 65, 139 PCA (principal components analysis), 379, 380 On-the-run series, Markit indexes, 577 Pension plans, 644, 645, 676–679 Open market operations, 56, 57 defi ned benefi t, 644, 645, 647, 675–683, 676e, Operating cash fl ow, 287 680e Option-adjusted price, 121 Percent in sector and quality, 693

bindex 910 24 August 2019 10:07 AM Index 911

Periodicity Prepayment penalty mortgages, 167 of annual rate, 115–116 Prepayment risk, 160, 171 Perpetual bonds, 6, 226 Prepayment rate measures, 171–173, 173e Perpetuity, 226 Present value of distribution of cash fl ows Pfandbriefe, 867 methodology, 693 Physical settlement, 575 Price paid, vs. quoted price, 107–109 PIK (payment-in-kind) coupon bonds, 29–30, 75 Price value of a basis point (PVBP), 234–235, Plain vanilla bonds, 6–7, 8e, 11 728, 739 Planned amortization class (PAC) tranches, Pricing 178–179, 179e, 180e bond markets and, 621 Pledges, negative, 16 credit default swaps and, 585–586 Pooled investment vehicles, 622, 634, 698 Primary bond markets, 57, 58–62 Portfolio construction, bottom-up, 840–841 Primary dealers, 62 Portfolio management, 605–637 Prime rate, 71 active management of, 617, 617e Principal components analysis (PCA), 379, 380 alternatives to direct investment in bonds in, 622 Principal repayment structures, 23–33 bond market liquidity and, 619–622 bullet bonds and, 23–25, 24e cash fl ow matching in, 611, 612–613, 612e, 614e sinking fund arrangements and, 26–27, 27e cash fl ows and, 608–609 Principle of no arbitrage, 398 decomposing expected returns in, Priority of claims, 265, 268–269 623–624, 627 Private placement, 58, 62 diversifi cation in, 606–608, 607e Probability of default (POD), 262, 509, 511, duration matching in, 611, 613–615, 614e 544–545, 544e, 581, 582e enhanced indexing in, 616–617, 617e Probability of survival, 582 fi xed-income mandates in, 611–619 Profi tability, 284 fi xed-income returns model for, 627–627 Projected benefi t obligation (PBO), 676–677, fi xed-income securities’ roles in, 3–4, 606–610 683, 686 horizon matching in, 614 Prospectuses, 157n1, 296 immunization, 611, 612, 613, 614 Protection leg, 583 infl ation hedging using, 609, 609e PSA (Public Securities Association) prepayment leverage and, 628–632 benchmark, 172 liability-based mandates in, 611–613 Public off erings (public off ers), 58–59 pure indexing in, 616, 617e Public Securities Association (PSA) prepayment taxation and, 632–635 benchmark, 172 total return mandate in, 615–617, 617e Pure discount bonds, 7, 67, 345. See also Zero- yield curve strategies in, 729–730 coupon bonds Portfolio modifi ed adjusted duration, 692 T-bills as, 61, 65 Portfolios. See also Bond portfolios; Credit Pure expectations theory, 364 portfolios Pure indexing, 616, 617e, 690 domestic bonds, 640–641 Putable bonds, 36–37, 229, 230e global bonds, 640, 641e convexity of, 473 management of. See Portfolio management defi ned, 438 Position sizes, 841, 857 embedded option in, 438 Positive butterfl y, 658 extendible bonds vs., 456 Positive impact investing opportunities, 842 interest rate volatility and, 446–451, 448e, Preferred habitat theory, 366–367 450e, 451e, 454–455, 455e Premium as liabilities, 646 issue at, 22 lockout periods of, 438 trading at, 6, 95 risky, 459–462, 460e, 461e, 462e Premium leg, 583 straight bonds vs., 437 Prepayment option, 167 valuation and analysis of, 441–464 Prepayment modeling, 172 valuation at zero volatility, 445–446, 445e

bindex 911 24 August 2019 10:07 AM 912 Index

Put options, 313, 438, 483, 571 Repurchase date, 85 PVBP (price value of a basis point), 234–235, Repurchase price, 85 728, 739 Required margin, 121–122 Required rate of return, 94 Q Required yield, 94 Qatar, 50 Required , 113 QE (quantitative easing), 367–368, 367e Reserve accounts, 14, 158, 182, 188 Quantitative easing (QE), 367–368, 367e Reserve funds, 14–15, 82–83 Quarterly income debt securities (QUIDS), 6 Residential mortgage loans, 164–167 Quarterly interest bonds (QUIBS), 6 amortization schedule and, 166 Quasi-government entities, 5 interest rate determination in, 165–166 Quasi-government bonds, 63, 69 lender’s rights in foreclosure in, 167 QUIBS (quarterly interest bonds), 6 maturity of, 165 QUIDS (quarterly income debt securities), 6 prepayment options and prepayment penalties Quoted margin, 121, 534 in, 167 Quoted price, vs. price paid, 107–109 recourse/non-recourse feature of, 167 Residential mortgage-backed securities (RMBS), R 169–182. See also Mortgage-backed Rapid amortization, 190 securities (MBS) Ratchet bonds, 476–477 agency, 169 Ratio analysis, 284–286, 287e cash fl ow characteristics of, 170 Real estate investment trusts (REITs), 864 cash fl ow construction, in, 172–174, 173e Real rate duration, 251 collateralized mortgage obligations and, Receive-fi xed swap, 680–682, 682e, 686, 709, 175–180, 177e, 179e, 180e 710, 740 credit portfolios with, 863, 864–865, 865e Reconstitution, 401 mortgage pass-through securities and, Recourse loans, 167 170–174 Recovery rates, 267–269, 267e, 268e, 509, 576 non-agency, 169, 182 Redemption value, 6 prepayment rate measures in, Redemption yield, 10, 98 171–172 Reduced-form credit analysis model, 522–526 prepayment risk and, 171 Reference entity, 571 weighted average life in, 173–174 Reference obligation, 571 Residual tranches, 183 Reference rates Restricted payments, 313 examples of, 7 Restricted subsidies, 313 fl oating-rate notes with, 7, 28, 32, 42, 51, 71 Restructuring, 575 interbank funds and, 83 Retail deposits, 82 inverse fl oaters and, 80–81 Retail investors, 56 money markets and, 53 Retail Price Index (RPI), 30, 67 participation instruments and, 80 Return Registered bonds, 19 about, 204 Regulatory considerations, 18–21 sources of, 204–211 Reinvestment risk, 27 Reuters electronic dealing system, 83 REITs (real estate investment trusts), 864 Reverse fl oating-rate notes (FRNs, fl oaters), Relative value analysis, 834–835 28–29 Relative value considerations, 852 Reverse repurchase agreements (repos), Repayment proceeds, source of, 12 85, 630 Repo margin, 86 Reviewable adjustable-rate mortgages Repo rate, 85, 630 (ARMs), 166 Repos (repurchase agreements), 84–85, 630–631 Riding the yield curve, 353, 731 Repo to maturity, 85 Risk measures, portfolio-level, 953 Repurchase agreements (repos), 84–85, 630–631 Risk-neutral probabilities, 509–510, 544

bindex 912 24 August 2019 10:07 AM Index 913

Risk-reward profi les Security selection approach, 832. See also Bottom- bond indenture and, 11 up approach Rivalry among competitors, 282 Segmented markets theory, 366 RMBS. See Residential mortgage-backed Sell convexity strategy, 731–732 securities Semi-annual bond basis yield, 116 Roll, 577 Semi-annual bond equivalent yield, 116 Rolldown returns, 634–624, 626 Senior debt, 13, 266, 558 Rolling down the yield curve, 353 Seniority rankings, 12–13, 76, 264–266, 264e, Royal Bank of Canada, 438 267, 268e Royal Dutch Shell, 691 Sequential-pay tranches, 176–178, 177e RPI (Retail Price Index), 30, 67 Serial maturity structure, 75–76 Running yield, 10 Set in arrears, 475 Russia, 19 Settlement of corporate notes and bonds, 77 S of credit default swaps, 575–576 Samurai bonds, 19 in secondary bond markets, 63–64 S&P. See Standard & Poor’s Shaping risk, 224, 377, 383, 728 Savings accounts, 82 Shelf registration, 59–60 Scenario analysis, 463–464, 464e, 858 Shift movement in yield curves, 798–799, 799e Scope Ratings AG, 555 Short-term funding (banks), 82–86 SEC (Securities and Exchange Commission), repurchase and reverse repurchase agreements 19n4, 157n1, 701 and, 86 Secondary bond markets, 57, 62–64 retail deposits and, 82 Secondary credit market liquidity, 853–856, wholesale funds and, 82–84 854e, 855e Sibor (Singapore interbank off ered rate), 7, 52 Second lien debt, 266 SIFMA (Securities Industry and Financial Sector allocation, 846–847, 847e Markets Association), 172 Sector and quality spread duration contribution, 693 Simple yield, 118 Sector classifi cations, 833 Singapore interbank off ered rate (Sibor), 7, 52 Sector/coupon/maturity cell weights, 693 Single monthly mortality rate (SMM), Sector/quality enhancements, 696 171–172 Secured bonds, 12 Single-name credit default swaps (CDSs), 571 Secured debt, 265 Single-price auction, 60 Secured overnight fi nancing rate (SOFR), 52 Sinking fund arrangements Securities and Exchange Commission (SEC), bond repayment and, 26–27, 27e, 439–440 19n4, 157n1, 701 credit risk reduction and, 76, 439 Securities Industry and Financial Markets term maturity structure and, 76 Association (SIFMA), 172 Sinking fund bonds (sinkers), 439–440 Securitization Small-denomination negotiable certifi cates of benefi ts to economies and fi nancial markets, deposit (CDs), 84 154–155 Smart beta, 703 defi ned, 153 SMM (single monthly mortality rate), 171–172 parties and roles in, 157–158 Socially responsible investing, 696. See also process of, 5, 155–163, 157e Environmental, social, and governance risks of, 155 (ESG) special purpose entities (SPEs) and, 156, SOFR (secured overnight fi nancing rate), 52 161–163 Soft put options, 483 structure of, 159–161 Sonia (Standing OverNight Index Average), 364 Securitized assets, 154 South Korea, 19 Securitized debt interbank off ered rate (Koribor) in, 52 credit analysis of, 554–558 yield curve movement in, 377, 377e, 378e, 289, types of, 555, 555e–556e 390e

bindex 913 24 August 2019 10:07 AM 914 Index

Sovereign bonds (sovereigns), 65–67 Standard North American Contract, characteristics of, 65–66 572–573 coupon payment structures for, 28 Standing OverNight Index Average (Sonia), 364 credit quality of, 66 Statistics, industry, 282 government backing of, 12 Steepness movement, 379 legal issuer of, 11 Step-up coupon bonds, 29 types of, 66–67 Stochastic default ratee credit analysis model, 523 Sovereign debt, 315–317 Straight bonds, 437, 441–442 Sovereign governments, 6 Strategic asset allocation, 701 Sovereign ratings, 66 Stratifi ed sampling, 696 Sovereign wealth funds, 50, 56, 296 Street convention, 118 Spain, 19, 65 Stripping, 401 Special purpose companies (SPCs), 11, 156 STRIPS (Separate Trading of Registered Interest Special purpose entities (SPEs) and Principal of Securities), 688 asset-backed securities and, 11, 13 Structural credit analysis model, 522–526 bankruptcy remoteness of, 12, 13, 156, 162, Structural industry changes, 856 195, 557 Structural model of default, 523–525, 524e collateralized or secured debt and, 557 Structural risk, 659 legal form for, 11–12, 156 Structural subordination, 273 securitization and, 12, 156 161–163 Structured fi nance products, 5, 79, 630 Special purpose vehicles (SPVs), 11, 156 Structured fi nancial instruments, 79–81, 630, Speculative bonds, 5 863–867 Split coupon bonds, 30 Structured interest-only tranches, 176n7 Spot curves, 336, 399, 722 Structured notes, 801–802 evolution of, 351–353 Structured subordination, 273 forward curves vs., 342–344, 343e, 344e Student loans, and asset-backed securities, 5, Spot interest rate. See Spot rates 154, 865 Spot rates, 336–354 , 266 active bond portfolio management and, Subordination, 14, 160, 182, 195, 865 351–354 Subsidies, restricted vs. unrestricted, 313 defi ned, 336 Substitutes, threat of, 281–282 forward rate model and, 338–346, 343e, 344e Substitution, in portfolio construction, 841 forward rates and, 339–341 Succession event, 575 time value of money and, 104–105, 336–337 Supplementary prospectus, 157n1 yield-to-maturity and, 346–348 Suppliers, power of, 281 Spot yield curve. Seee Spot curve Supply, in portfolio construction, 839 Spread curves, 837–838, 838e, 850, 850e Support tranches, 178–179, 179e, 180e Spread duration, 693, 819, 841, 845 Supranational bonds, 69–70 Spread over the benchmark, 113 Supranational organizations, 6, 69 Spread risk, 263, 819–820 Surety bonds, 15 Spreads, 7 Surplus, 674 benchmarks and, 138 Survival, probability of, 582 Spread sensitivity to fund outfl ows, 854–855, Swap agreement, 629 854e Swap curves. Seee Swap rate curves SPVs. See Special purpose vehicles) Swap rates, 355 Standard & Poor’s, 5n2, 270–271, 692 credit spread over, 551e bond ratings by, 5n2, 49 Swap rate curves, 355–364, 357e commercial paper ratings by, 72e Swap spread, 360–361 credit ratings by, 161, 271–273, 272e, 518 Synchrony Credit Card Master Note Trust, 555, global corporate default rates from, 274, 275e 555e, 557 notching by, 273–274, 274e Syndicated loans, 63, 71 sovereign credit analysis by, 66, 316 Syndicated off erings, 58

bindex 914 24 August 2019 10:07 AM Index 915

Syndicates, 71 Time value of money Synthetic collateralized debt obligations characteristics and, 100–104, 101e, 102e, 104e (CDOs), 596 market discount rate and, 94–96, 101 spot rates and, 104–105, 336–337 T yield-to-maturity and, 98–99 Tactical asset allocation, 701 TIPS (Treasury Infl ation-Protected Securities), Tail risk, 857–859 30–31, 60, 67, 646 Tail risk hedges, 859 Tokyo interbank off ered rate (Tibor), 52, 355 Taxation Top-down approach, 832, 842–852 fi xed-income portfolio and, 632–635 Total return mandate, 611, 615–617, 617e investment vehicles and, 634 Total return payer, 699 Taxation valuation adjustment (TVA), 543 Total return receiver, 699 Tax considerations, 21–22 Total return swap (TRS), 699–700, 700e Tax-exempt bonds TRACE (Trade Reporting and Compliance callable, 438 Engine), 621, 692, 853, 862 fi xed income markets classifi ed by, 54 Tracking error, 615, 694 municipal bonds as, 54, 438 Tracking risk, 615, 690 TED spread, 363, 363e Trade Reporting and Compliance Engine Tennessee Valley Authority (TVA), 477, 477e (TRACE), 621, 692, 853, 862 Tenor, 6, 134, 139 Trading volume, 853–854, 854e Term certifi cates of deposit (CDs), 84 Trance credit default swaps (CDSs), 571, 572 Term life insurance policies, 646 TransCanada Corporation, 550 Term premium, 371 Transition matrixes, 520–521, 521e Term repo, 85 TransUnion, 517 Term structure Treasuries. See Treasury securities of corporate notes and bonds, 76 Treasury bills (T-bills), 65 of credit spreads, 113, 161–162, 548–554, Treasury bonds (T-bonds), 65, 365 552e–553e Treasury Infl ation-Protected Securities (TIPS), of interest rates, 364–376 30–31, 60, 67, 646 of volatility, 382, 382e Treasury notes (T-notes), 65, 671, 672, 686 of yield volatility, 245–246 Treasury public auction, 60–62, 61e Term structure of interest rates Treasury securities (Treasuries) active bond portfolio management and, composite yield of, 548, 548e 351–354 historical volatility structure of, 382e arbitrage free models of, 374–376 as sovereign bonds, 65, 66 Cox–Ingersoll–Ross model of, 370–372, 372e swap spread for, 360 equilibrium term structure models of, 369–376 trading volume in markets for, 854 Ho–Lee model of, 374–375 yield curves for, 379e, 380e liquidity preference theory of, 365–366 Treasury STRIPS (Separate Trading of Registered local expectations theory of, 364–365 Interest and Principal of Securities), 688 preferred habitat theory of, 366–367 TRS (total return swap), 699–700, 700e segmented markets theory of, 386 True yield, fi xed-rate bonds, 118 spot rates and forward rates in, 355–364, 357e Trust deed, 10, 296 swap rate curves and, 355–364, 357e Trustees, 10–11, 26, 59, 158, 440 swap spreads and, 360–361 Turboing, 15 Vasicek model of, 372–373, 373e Twist movement in yield curves, 799, 799e yield-to-maturity and spot rates and, 346–348 Th reat of entry, 281 U Th reat of substitutes, 281–282 Ultra 10-year Treasury futures contract, 679 Tibor (Tokyo interbank off ered rate), 52, 355 Unbiased expectations theory, 364 Time, credit rating changes over, 275–276, 277e Underwriters, 59 Time tranching, 160, 161 Underwritten off erings, 59–60

bindex 915 24 August 2019 10:07 AM 916 Index

Unencumbered assets, 16 Warrants, 38–39 United Kingdom Waste Management Utility PLC (WMU), 481, bonds in, 11, 19, 438, 609 481e–482e, 482 debt and equity outstanding in, 49 Waterfall structure, 14, 160, 268–269 gilts as benchmark in, 360, 401, 437 Weighted average coupon rate (WA C), 170 infl ation-linked bonds in, 67 Weighted average life, 173–174 sovereign rating of, 66 Weighted average maturity (WA M), 170 tax-exempt bonds in, 54 When issued market, 59 UK Debt Management Offi ce, 11 Wholesale funds, 82–84 United States World Bank, 69, 70, 315n43, debt and equity outstanding in, 49 infl ation-linked bonds in, 31, 609 Y sovereign bond market in, 60, 67 Yankee bonds, 19 sovereign rating of, 66 Yield US commercial paper (USCP), 73–74, 73e, 74e on bonds, components of, 542–543, 542e Unrealized capital gains and losses, 247 on corporate bonds, 12 Unrestricted subsidies, 313 on sovereign bonds, 12 Unsecured bonds, 12–13 Yield curve enhancements, 696 Unsecured debt, 265 Yield curve factor models, 378–385, 379e, 380e, Upfront payment, 573–574 381e Upfront premium, 574 Yield curve movement, 377, 377e, 378e USCP (US commercial paper), 73–74, 73e, 74e Yield curve risk, 383–385 Yield curves V bonds and, 130, 131, 132, 133 Valuation butterfl y spread on, 726–727, 727e of bonds, at interest tree nodes, 408, 408e valuation, 448–450, 449e of capped fl oaters (fl oating-rate bonds), defi ned, 722–723 475–476, 476e duration measures for, 727–728 of convertible bonds, 487–492, 481e–482e forward curve and, 349–354 of credit default swaps, 587–588 for government bonds, 132e, 140 of default-free and option-free bonds, 442–443, Ho–Lee model and, 374 442e during Long-Term Capital Management crisis of default-free callable and putable bonds, (1998), 723, 723e 443–446, 444e, 445e parallel shirt in, 232, 724 of fl oored fl oaters (fl oating-rate bonds), putable , 450–452, 451e 479–480, 478e review of dynamics of, 724–729, 724e, 725e, pathwise, in arbitrage-free framework, 419–421, 726e 420e, 421e riding, 353 of risky callable and putable bonds, 459–462, rolling down, 353 460e, 461e, 462e three primary forms of, 722 Variable-rate mortgages, 165–166 Yield curve strategies, 721–804 Vasicek model, 372–373, 373e bullet and barbell structures in, 742–746, Verizon, 837–838, 838e 743e–744e, 745e, 752–755, 753e Volatility butterfl y trades in, 761–763, 762e of interest rates, 407–408 buy and hold in, 730–731 of yield curves, 382, 382e buy convexity in, 741–742, 742e Volatility management, 840 carry trades in, 732–736, 733e Volcker Rule, 856 changes in market level, slope, or curvature and, 730, 737–747 W classifi cation of, 730 WA C (weighted average coupon rate), 170 comparing various duration-neutral portfolios WA M (weighted average maturity), 170 in, 784–792

bindex 916 24 August 2019 10:07 AM Index 917

duration management in, 737–746, 738e fi xed-income valuation and, 138–142, 139e, duration-neutral bullet and barbell portfolio in, 141e 752–755, 753e–755e Yield to call (YTC), 298n31 duration positioning in, 748–752, 748e, 749e, Yield-to-maturity (YTM), 10 751e rate of return under, 206 fl attening curve in, 745–746, 745e–746e realized horizon yield and, 207 inter-market strategies in, 770–784 spot rates and, 346–348 major types of active strategies, 729–747 time value of money and, 98–99 manager’s tools in, 730 Yield-to-redemption, 10, 98. See also Yield-to- options in, 765–770, 766e–770e maturity review of curve dynamics in, 724–729, 724e, Yield to worst (YTW), 120, 298n31 725e, 726e Yield volatility, 245–246 riding the yield curve in, 731 YTC (yield to call), 298n31 sell convexity in, 731–732 YTM. See Yield-to-maturity stable yield curve assumption and, 730–736 YTW (yield to worst), 120, 298n31 standard scenarios and language in describing, 798–799, 799e Z structured notes in, 801–802 Zero-coupon bonds, 30 trade evaluation framework in, 793–794 convexity of, 729 Yield curve trades, 353–354 default probability of, 551–552, 551e–552e Yield duration, 213, 220, 223 implied interest on, 7 Yield enhancement instruments, 79–80 payment structures of, 75 Yield measures as sovereign bonds, 67 bonds and, 10 spot curve and, 336 fi xed-income valuation and, 114–130 Zero-coupon-indexed bonds, 32 fl oating-rate notes and, 121–124 Zero-coupon rates, 345–346 money market instruments and, 125–130 Zero-spread (Z-spread), 361–362, 829, 830 Yield spreads Zero volatility spreads (Z-spreads), 140–142, 872 credit analysis and, 298–307, 298e, 299e, 301e Z-spread (zero-spread), 361–362, 829, 830

bindex 917 24 August 2019 10:07 AM