The page numbers in this index refer to the printed version of this book. The link provided will take you to the beginning of that print page. You may need to scroll forward from that location to find the corresponding reference on your e-reader.
Page numbers in bold indicate tables; those in italics indicate figures.
A/360 calendar convention. See actual/360 (A/360) calendar convention
A/365 calendar convention, 30, 31
AA (actual/actual) calendar convention, single cash flow yield calculations, 28, 30, 31, 34, 37, 40–41
active portfolio management, xiv, 197–212
covered option writing strategy, 212
credit spread declines, four ETF approach (outperforming an index strategy), 199
currency (multiple) strategy, 212
exchange-traded funds (ETFs), 198, 199–200
four ETF approach (outperforming an index strategy), 198, 199–200
future credit quality strategy, 212
inflation risk and total return strategy, xiv, 205–6, 206, 208, 209
interest rate declines, four ETF approach (outperforming an index strategy), 199–200
interest rate risk and total return strategy, 203, 203, 203–4, 204, 205, 207, 208, 208, 209, 209, 210, 210, 211
interest rate volatility increases, four ETF approach (outperforming an index strategy), 199
liquidity approach (outperforming an index strategy), 198, 199
outperforming an index strategy, 197–200, 198
riding the yield curve (total return strategy), 200, 201, 201–5, 202, 202, 203, 203, 204, 205
three ETF approach (outperforming an index strategy), 198, 200
total return strategy, 197, 200–212, 201, 202, 202, 203, 203, 204, 205, 206, 207, 208, 209, 210, 211
US Corporates, 197, 198, 198, 200
US Treasuries, 197, 198, 198, 199–200
yield curve plays (total return strategy), 200, 205–11, 206, 207, 208, 209, 210, 211
zero coupon bonds (ZCBs) example, 206–7
See also fixed income investments
actual/360 (A/360) calendar convention
multiple cash flows calculations, 51–52, 58–59, 63
single cash flow yield calculations, 29, 30, 33, 35, 36, 37–38, 40, 41
See also calendar conventions
actual/actual (A/A) calendar convention, single cash flow yield calculations, 28, 30, 31, 34, 37, 40–41
after-tax RCY, 76–80, 77, 78, 79, 80
agencies, 30, 187, 197, 198, 198, 200
AGG (iShares Core Total US Bond Market ETF), 187
alternative debt instruments and duration, 127–29
annual credit spread, pricing credit risk, 176–77, 176–77
asset allocation (automatic), convertibles, 20
automatic tactical asset allocation, convertibles, 20
bankers acceptances, 30
bank loans, debt market, 14–15
bankruptcy and bonds, pricing credit risk, 179, 179–84, 181, 182–83
barbell vs. bullets trade, 148, 148–49, 149
Barclays Aggregate Taxable Index, 197–98, 198
Barclays Capital US Aggregate Bond Index (Lehman Aggregate), 187
“base e,” multiple cash flows calculations, 60, 62
basic bond yield calculations. See bond yield calculations
basis point defined, 131–32
benchmark (outperforming), convertibles, 20–21
binomial trees, embedded options risk, 160, 160, 161, 162, 164, 168, 168, 169, 171, 172
“black box,” pricing credit risk, 179, 179–80
Bloomberg, 154
Bloomberg Single Factor Option-Adjusted Spread (OAS) Model, 159, 164–69, 166, 168, 169
BND (Vanguard Total Bond Market ETF), 187
bonds with different ratings, credit risk, 172
bond yield calculations, 64–81
after-tax RCY, 76–80, 77, 78, 79, 80
coupon yield, 64–65, 69, 70–71
current yield (cash-on-cash return), 65–66
embedded options, 72
eurobonds examples, 66–68, 70, 70, 76–77
inflation risk, xiv, 72, 75, 79, 80–81
interest on interest (IOI), 73, 74, 77–78, 78
interest rate risk and, 69, 71, 76
life insurance companies, 79
net-net realized compound yield (NNRCY), 80–81
net realized compound yield (NRCY), 76–80, 77, 78, 79, 80
realized compound yield (RCY), 72–76, 74–75, 76
reinvestment issue, 72–73, 75, 77, 79, 80
retired welder example, 65–66
tax-free vs. taxable investments, 76–78, 77
tax issue, 72, 75–76, 76–80, 77, 78, 79, 80
total return in dollars (T–R), 73–74, 74
yield-to-call, 72
yield to maturity (YTM), xiv, 66–71, 70–71, 72–73, 75, 76, 76, 80
yield-to-put, 72
yield-to-worst, 72
zero coupon bonds (ZCBs), 69, 70, 70–71, 74–75
See also investment math
bootstrapping the zero coupon curve, 82–85, 83, 84, 85
See also investment math
borrower (issuer), debt market, 1, 3
British government bonds (Gilts), 31
building example, 7
bullet bonds and positive convexity, 139, 141
Bullet Loan (fixed) debt, 6
bullet vs. barbell trade, 148, 148–49, 149
Bunds (German government bonds), 31
C. See convexity
calculations. See investment math
calendar conventions
A/365 calendar convention, 30, 31
actual/actual (A/A) calendar convention, single cash flow yield calculations, 28, 30, 31, 34, 37, 40–41
single cash flow yield calculations and, xiv, 28–31, 30, 31, 32, 33
See also actual/360 (A/360) calendar convention; investment math; 30/360 calendar convention
call options
convexity (C), 140–41
debt market, 8–9
duration variables, 126–27
embedded options risk, 159
See also embedded options
capital expenditures (CapX), pricing credit risk, 180–81, 181
capital structure
bankruptcy, pricing credit risk, 182, 182, 183, 183
CapX (capital expenditures), pricing credit risk, 180–81, 181
cash flow and bankruptcy, pricing credit risk, 180–82, 181
cash flow calculations. See investment math
cash-on-cash return (current yield), 65–66
CMOs, 30
COFI, 4
commercial paper, 30
common stock. See stocks
compounding frequencies, multiple cash flows calculations, xiv, 54–55, 55
compound interest, single cash flow yield calculations, 26
conditional probability of survival (CPS), pricing credit risk, 175, 175–76, 176–77
constant yield and convexity, 145–49, 146, 147, 148, 149
continuous compounding
multiple cash flows calculations, 60–63
single cash flow yield calculations, 26
See also investment math
conversion premium, convertibles, 18
conversion value, convertibles, 17
convertibles, 16–24
automatic tactical asset allocation, 20
call date/risk, xiii, 18, 21–22
conversion premium, 18
conversion value, 17
higher current income, 20
loss of accrued interest upon forced call, 22
lower liquidity, 22–23
outperforming a benchmark, 20–21
risk adjusted return, 20
senior security, 19
underperforming the common, 21
work-out period, 18–19
See also debt market; embedded options
bullet bonds and positive convexity, 139, 141
bullet vs. barbell trade, 148, 148–49, 149
call options, 140–41
constant yield and coupon, 145, 147, 147–49, 148, 149
constant yield and maturity, 145–46, 146
constant yield and modified duration impact, 145, 147
definitions of convexity, 135, 149
derivative defined, 135–36, 149
embedded options and, 140–41
eurobonds example, 136–38, 137, 138, 141–42, 141–44
factors impacting, 145–49, 146, 147, 148, 149
higher derivatives and, 149
interest rate risk and, 136, 138, 139, 140–41, 142, 143, 144, 145, 146, 147, 148
location, speed, acceleration example, 135–36
modified convexity, 141–42, 141–42
modified duration (MD) and, 135, 136, 145, 147, 149
negative convexity, 139–40, 140, 140–41
positive convexity, 137, 138, 139, 140, 141
price yield function of a bond, 136–45, 137, 138, 140, 141–42
zero coupon bonds (ZCBs), 144–45, 146, 146, 147, 147–49, 148, 149
See also fixed income investments
corporates. See US Corporates
cost of analysis risk, credit risk, 152, 155–56, 164
coupon and yield constant, convexity, 145, 147, 147–49, 148, 149
coupon (interest rate), debt market, 1, 3–6, 4, 5
coupon size, duration variables, 118–21, 120, 121
coupon yield, bond yield calculations, 64–65, 69, 70–71
covenants, debt market, 3
covered option writing strategy, active portfolio management, 212
CPS (conditional probability of survival), pricing credit risk, 175, 175–76, 176–77
credit convexity risk, 152, 158, 158, 164
credit drift risk, 152, 156–57, 157, 164
credit protection, 151
credit quality
active portfolio management and, 212
deterioration, credit risk, 150–51
passive fixed income portfolio management (ladder portfolios), 186
credit requirements (dedicated portfolios), passive fixed income portfolio management, 191
bonds with different ratings, 172
cost of analysis risk, 152, 155–56, 164
credit convexity risk, 152, 158, 158, 164
credit drift risk, 152, 156–57, 157, 164
credit protection, 151
downgraded bonds, 150–51
industrial bonds example, 156–57, 157
liquidity risk, 152, 154–55, 164
quality of credit deterioration, 150–51
ratings (different), bonds with, 172
uncertainty risk, 152, 158–59, 164
US Corporates, 153, 154, 155–56
US Treasuries, 152, 153, 154–55, 158, 158
See also embedded options risk; fixed income investments; pricing credit risk
credit spread, debt market, xiv, 4, 4–5
credit spread declines, four ETF approach (outperforming an index strategy), 199
currency (multiple) strategy, active portfolio management, 212
current income (higher), convertibles, 20
current yield (cash-on-cash return), 65–66
daily interest, single cash flow yield calculations, 38–39
debt load and bankruptcy, pricing credit risk, 182–83, 182–83
debt market, 1–24
bank loans, 14–15
building example, 7
call options, 8–9
covenants, 3
defined, 1
derivative obligations, 15
embedded options, 7–9
equity market vs., 1
extendable debt, 6–7
fixed (Bullet Loan) debt, 6
floating rate notes (FRNs), xiii, 4, 4–6, 5, 11, 128–29
global debt market, 1
“hard” put option, 8
income bonds, 24
interest payment frequency, 1, 2
interest rate (coupon), 1, 3–6, 4, 5
life of the option, 8
maturity of debt, 1, 2, 6–11, 10
off balance sheet financing structure, 13, 13–14
principal, 1
secured debt with recourse, 14
segmentation based on maturity, 2
senior debt with no recourse, 13, 13–14
“soft” put option, 8
special purpose corporation (SPC), 13, 13–14
subordinated debt, 16, 182, 182, 183, 183–84
targeted redemption note (TARN), 11
trade obligations, 15–16
See also convertibles; fixed income investments
dedicated portfolios (fund liabilities), passive fixed income portfolio management, 185, 188–92, 189, 190
default probability determination, pricing credit risk, 177–79, 178–79
derivative defined, 135–36, 149
derivative obligations, debt market, 15
derivative of modified duration, 213–18
differing compounding frequencies, multiple cash flows calculations, xiv, 54–59, 55, 57, 58, 59
discount instruments, 42–44
See also investment math
downgraded bonds, credit risk, 150–51
duration calculations, 102–17
definitions of duration, 102, 103–4
derivative of modified duration, 213–18
eurobonds example, 110
Excel example, 114–16, 115, 117, 117
HP-12C example, 219–20, 219–21
Macaulay’s duration, 113, 217–18
present value (PV), 111, 111–12, 112, 112, 114
problems (time discounting future cash flows), 113–17, 114, 115, 116, 117
problems (time-weighting future cash flows), 108–10, 110
time discounting future cash flows, 111, 111–17, 112, 112, 113, 114, 115, 116, 117
time-weighting future cash flows, 107–10, 110, 111, 113, 113
total return in dollars (T–R) and, 102, 102–3, 103, 104, 113
yield to maturity (YTM) and, 104, 104–6, 105, 106, 111, 114
zero coupon bonds (ZCBs), 116, 116–17
See also duration variables; interest rate risk vs. reinvestment risk; investment math; modified duration (MD)
duration variables, xiv, 118–29
alternative debt instruments and duration, 127–29
call options, 126–27
eurobonds with various coupons, 121, 121
floating rate notes (FRNs), xiii, 4, 4–6, 5, 11, 128–29
high coupon bonds, 119–20, 120
interest rate swaps, 2, 30, 128–29
maturity of the bond, 118, 121–22, 122, 127
moving target, duration as a, 127
payment of interest, 118, 125, 125–26, 126
preferred stock and duration, 128, 129
size of the coupon (coupon size), 118–21, 120, 121
US Corporates, 123
yield to maturity (YTM), 118, 122–23, 123, 127
zero coupon bonds (ZCBs), 120, 120, 124
See also duration calculations; fixed income investments; modified duration (MD)
Dutch government bonds (Guilders), 31
effective returns vs. stated returns, multiple cash flows calculations, 54
embedded options
bond yield calculations, 72
convexity (C), 140–41
debt market, 7–9
duration variables, 118, 126–27
passive fixed income portfolio management (dedicated portfolios), 192
See also call options; convertibles; embedded options risk; put options
embedded options risk, 127, 152, 159–72
binomial trees, 160, 160, 161, 162, 164, 168, 168, 169, 171, 172
Bloomberg Single Factor Option-Adjusted Spread (OAS) Model, 159, 164–69, 166, 168, 169
call options, 159
interest rate risk and, 169–71, 170
Interest Rate Swap curve, 164–65
simplified embedded option pricing model, 159–64, 160, 161, 162, 163, 164
valuing embedded options, 171, 171–72, 172
volatility impact on price, 169–71, 170
See also credit risk; embedded options
emerging markets, 31
equity market vs. debt market, 1
ETFs. See exchange-traded funds
eurobonds
calendar conventions and, 30
compounding frequencies, 54
interest payment frequency, 2
various coupons, duration variables, 121, 121
See also eurobonds examples
eurobonds examples
bond yield calculations, 66–68, 70, 70, 76–77
bootstrapping the zero coupon curve, 82–85, 83, 84, 85
convexity (C), 136–38, 137, 138, 141–42, 141–44
duration calculations, 110
nonparallel yield curve shifts, 95, 96
passive fixed income portfolio management, 189, 189–91, 190
See also eurobonds
duration calculations, 114–16, 115, 117, 117
single cash flow yield calculations, 31
valuing bonds using the zero curve, 89, 89, 89–90, 90
See also investment math
exchange-traded funds (ETFs)
active portfolio management, 198, 199–200
passive fixed income portfolio management, 187
exponent function, multiple cash flows calculations, 47, 48, 50
extendable debt, 6–7
Fed, 155, 205–6, 206, 208, 209, 209, 210, 210, 211
finite compounding, multiple cash flows calculations, 48–54, 53
5-year US Treasuries, 2
fixed (Bullet Loan) debt, 6
fixed income investments, xiii–xiv
speculative nature of, xiii
See also active portfolio management; capital structure; convexity (C); credit quality; credit risk; debt market; duration; embedded options; eurobonds; exchange-traded funds (ETFs); inflation risk; investment math; liquidity; maturity; mortgages; passive fixed income portfolio management; reinvestment; taxes; US Corporates; US Treasuries; zero coupon bonds (ZCBs)
fixed side of swaps, 30
floating rate notes (FRNs), xiii, 4, 4–6, 5, 11, 128–29
floating side of swaps, 30
forced call, convertibles, 22
formulas. See investment math
four ETF approach (outperforming an index strategy), 198, 199–200
French government bonds (OATS), 31
FRNs (floating rate notes), xiii, 4, 4–6, 5, 11, 128–29
fund liabilities, passive fixed income portfolio management, 185, 188–96, 189, 190, 193, 193, 194, 195, 196
future credit quality strategy, active portfolio management, 212
future value (FV)
multiple cash flows calculations, 45–46, 46–47, 48, 60–61
single cash flow yield calculations, 25–26, 27, 39–40
valuing bonds using the zero curve, 87
See also investment math
FV. See future value
German government bonds (Bunds), 31
Gilts (British government bonds), 31
global debt market, 1
Guilders (Dutch government bonds), 31
“hard” put option, 8
high coupon bonds, duration variables, 119–20, 120
higher current income, convertibles (current income (higher), convertibles), 20
higher derivatives and convexity (C), 149
HP-12C examples
duration calculations, 219–20, 219–21
multiple cash flows calculations, 47, 47, 48, 50, 56, 57, 58, 59
single cash flow yield calculations, 31–33
See also investment math
immunized portfolios (fund liabilities), passive fixed income portfolio management, 185, 192–96, 193, 193, 194, 195, 196
impact of nonparallel yield curve shifts. See nonparallel yield curve shifts
income bonds, debt market, 24
index matching (tie the market), passive fixed income portfolio management, 185, 187
industrial bonds example, 156–57, 157
inflation risk
bond yield calculations, xiv, 72, 75, 79, 80–81
total return strategy and, xiv, 205–6, 206, 208, 209
interest bearing equivalent, discount instruments, 42–44
interest loss (forced call), convertibles, 22
interest on interest (IOI)
bond yield calculations, 73, 74, 77–78, 78
interest rate risk vs. reinvestment risk, 97, 98, 100–107, 101, 101, 102, 103, 104, 105, 106
single cash flow yield calculations, 26
See also investment math
interest payment frequency, debt market, 1, 2
interest rate (coupon), debt market, 1, 3–6, 4, 5
interest rate declines, four ETF approach (outperforming an index strategy), 199–200
interest rate risk and
bond yield calculations, 69, 71, 76
convexity (C), 136, 138, 139, 140–41, 142, 143, 144, 145, 146, 147, 148
embedded options risk, 169–71, 170
modified duration (MD), 130–31, 131, 133, 134, 136
nonparallel yield curve shifts, 95, 96
passive fixed income portfolio management, 187
total return strategy, 203, 203, 203–4, 204, 205, 207, 208, 208, 209, 209, 210, 210, 211
See also interest rate risk vs. reinvestment risk; investment math
interest rate risk vs. reinvestment risk, 97–117
interest on interest (IOI), 97, 98, 100–107, 101, 101, 102, 103, 104, 105, 106
market value (MV), 97, 98, 99, 99–100, 100, 101, 101, 101, 102
total return in dollars (T–R), 97–98, 101–2, 113
See also duration calculations; interest rate risk; investment math
Interest Rate Swap curve, embedded options risk, 164–65
interest rate swaps, 2, 30, 128–29
interest rate volatility increases, four ETF approach (outperforming an index strategy), 199
investment math, 25
bootstrapping the zero coupon curve, 82–85, 83, 84, 85
discount instruments, 42–44
nonparallel yield curve shifts, 94–96, 96
See also bond yield calculations; calendar conventions; continuous compounding; duration calculations; Excel examples; fixed income investments; future value (FV); HP-12C examples; interest on interest (IOI); interest rate risk; multiple cash flows calculations; present value (PV); problems; single cash flow yield calculations; spot rates; total return in dollars (T–R); valuing bonds using the zero curve; yield to maturity (YTM)
investor (lender), debt market, 1, 3
IOI. See interest on interest
iShares Core Total US Bond Market ETF (AGG), 187
issuer (borrower), debt market, 1, 3
Japanese government bonds (JGBs), 31
key rate durations, modified duration (MD), 133–34, 134, 134
ladder portfolios (tie the market), passive fixed income portfolio management, 185, 186–87
LAG (SPDR Lehman Aggregate Bond ETF), 187
Lehman Aggregate (Barclays Capital US Aggregate Bond Index), 187
lender (investor), debt market, 1, 3
length variable (ladder portfolios), passive fixed income portfolio management, 186
LIBOR (London Interbank Offering Rate), 4, 4, 5, 5
life insurance companies, 79
life of the option, debt market, 8
liquidity
convertibles and lower liquidity, 22–23
credit risk and, 152, 154–55, 164
outperforming an index strategy and, 198, 199
loans. See debt market
location, speed, acceleration example, 135–36
London Interbank Offering Rate (LIBOR), 4, 4, 5, 5
long-term returns, multiple cash flows calculations, 46–54
loss of accrued interest upon forced call, convertibles, 22
lower liquidity, convertibles (liquidity (lower), convertibles), 22–23
Macaulay, Frederick, 113
Macaulay’s duration, 113, 217–18
market value (MV), interest rate risk vs. reinvestment risk, 97, 98, 99, 99–100, 100, 101, 101, 101, 102
math. See investment math
maturity
debt market and, 1, 2, 6–11, 10
duration variables, 118, 121–22, 122, 127
mismatches (dedicated portfolios), passive fixed income portfolio management, 192
See also yield to maturity (YTM)
MD. See modified duration
microeconomic credit analysis, 155
mirror index (tie the market), passive fixed income portfolio management, 185, 187
modified convexity, 141–42, 141–42
modified duration (MD), xiv, 130–34
basis point defined, 131–32
convexity (C), 135, 136, 145, 147, 149
derivative of modified duration, 213–18
HP-12C example, 219–20, 219–21
interest rate risk and, 130–31, 131, 133, 134, 136
key rate durations, 133–34, 134, 134
problems, 132–33
See also duration
money market funds, 2
mortgages
active portfolio management, 197, 198, 205–6
calendar conventions, 30
compounding frequencies, 54
convexity (C), 139–40, 140, 149
interest payment frequency, 2
passive fixed income portfolio management, 187
moving target, duration as a, 127
multiple cash flows calculations, 45–63
actual/360 (A/360) calendar convention, 51–52, 58–59, 63
compounding frequencies, xiv, 54–55, 55
continuous compounding, 60–63
differing compounding frequencies, xiv, 54–59, 55, 57, 58, 59
effective returns vs. stated returns, 54
future value (FV), 45–46, 46–47, 48, 60–61
HP-12C example, 47, 47, 48, 50, 56, 57, 58, 59
long-term returns, 46–54
natural log of base e raised to a power, 62
present value (PV), 46, 47, 60–61
problems (continuous compounding), 61–63
problems (differing compounding frequencies), 55–59, 57, 58, 59
problems (finite compounding), 48–54, 53
30/360 calendar convention, 46–47, 48, 49, 50, 51, 57, 62–63
zero coupon bonds (ZCBs), 47, 55–56, 57, 58–59
See also investment math
multiple currency strategy, active portfolio management, 212
municipals, 30, 54, 198, 199, 200
MV (market value), interest rate risk vs. reinvestment risk, 97, 98, 99, 99–100, 100, 101, 101, 101, 102
natural log of base e raised to a power, multiple cash flows calculations, 62
negative convexity, 139–40, 140, 140–41
net-net realized compound yield (NNRCY), 80–81
net realized compound yield (NRCY, after-tax RCY), 76–80, 77, 78, 79, 80
NNRCY (net-net realized compound yield), 80–81
nonparallel yield curve shifts, 94–96, 96
See also investment math
notes. See debt market
NRCY (net realized compound yield), 76–80, 77, 78, 79, 80
OAS (Bloomberg Single Factor Option-Adjusted Spread) Model, 159, 164–69, 166, 168, 169
OATS (French government bonds), 31
off balance sheet financing structure, debt market, 13, 13–14
1-year US Treasuries, 113
Option-Adjusted Spread (OAS) Model, Bloomberg Single Factor, 159, 164–69, 166, 168, 169
outperforming a benchmark, convertibles, 20–21
outperforming an index strategy, active portfolio management, 197–200, 198
outperforming the market, 197
See also active portfolio management
parallel yield curve shift, 94, 94
passive fixed income portfolio management, xiv, 185–96
credit quality (ladder portfolios), 186
credit requirements (dedicated portfolios), 191
dedicated portfolios (fund liabilities), 185, 188–92, 189, 190
embedded options (dedicated portfolios), 192
eurobonds example, 189, 189–91, 190
exchange-traded funds (ETFs), 187
fund liabilities, 185, 188–96, 189, 190, 193, 193, 194, 195, 196
immunized portfolios (fund liabilities), 185, 192–96, 193, 193, 194, 195, 196
index matching (tie the market), 185, 187
interest rate risk and, 187
ladder portfolios (tie the market), 185, 186–87
length variable (ladder portfolios), 186
maturity mismatches (dedicated portfolios), 192
mirror index (tie the market), 185, 187
mortgages, 187
rebalancing the hedge, 195–96, 196
rung spacing (ladder portfolios), 186
US Corporates, 187
zero coupon bonds (ZCBs), fund liabilities, 185, 188
zero coupon bonds (ZCBs) example, 193, 193–96, 194, 195, 196
See also fixed income investments
payment of interest, duration variables, 118, 125, 125–26, 126
period of put protection, 7
positive convexity, 137, 138, 139, 140, 141
preferred stock and duration, 128, 129
present value (PV)
duration calculations, 111, 111–12, 112, 112, 114
multiple cash flows calculations, 46, 47, 60–61
nonparallel yield curve shifts, 95, 96
single cash flow yield calculations, 25–26, 27–28
valuing bonds using the zero curve, 86–87, 87
See also investment math
price yield function of a bond, 136–45, 137, 138, 140, 141–42
pricing credit risk, xiv, 173–84
annual credit spread, 176–77, 176–77
bankruptcy and bonds, 179, 179–84, 181, 182–83
capital expenditures (CapX), 180–81, 181
capital structure and bankruptcy, 182, 182, 183, 183
cash flow and bankruptcy, 180–82, 181
conditional probability of survival (CPS), 175, 175–76, 176–77
debt load and bankruptcy, 182–83, 182–83
default probability determination, 177–79, 178–79
problems, 174–77, 175, 176–77, 181–84, 182–83
stock (buying) and bankruptcy, 184
subordinated debt, 16, 182, 182, 183, 183–84
US Corporates, 173, 174, 177, 178, 178–79
US Treasuries, 173, 177–78, 178–79
See also credit risk
Prime interest rate, 4
principal, debt market, 1
printing of money and debt of Western governments, xiii
problems
discount instruments, 43–44
duration calculations (time discounting future cash flows), 113–17, 114, 115, 116, 117
duration calculations (time-weighting future cash flows), 108–10, 110
modified duration (MD), 132–33
multiple cash flows calculations (continuous compounding), 61–63
multiple cash flows calculations (differing compounding frequencies), 55–59, 57, 58, 59
multiple cash flows calculations (finite compounding), 48–54, 53
passive fixed income portfolio management, 189, 189–91, 190
pricing credit risk, 174–77, 175, 176–77, 181–84, 182–83
single cash flow yield calculations, 32–41
valuing bonds using the zero curve, 90–93, 91, 92, 93
See also investment math
put options
See also embedded options
PV. See present value
rate conversion, multiple cash flows calculations, 55–56, 57
ratings (bonds with different), credit risk, 172
RCY (realized compound yield), 72–76, 74–75, 76
realized compound yield (RCY), 72–76, 74–75, 76
rebalancing the hedge, passive fixed income portfolio management, 195–96, 196
reinvestment
bond yield calculations and, 72–73, 75, 77, 79, 80
See also interest rate risk vs. reinvestment risk
repurchase agreements, 30
retired welder example, 65–66
riding the yield curve (total return strategy), 200, 201, 201–5, 202, 202, 203, 203, 204, 205
risk adjusted return, convertibles, 20
risk and duration calculations, 103–4, 104, 106
See also credit risk; embedded options risk; inflation risk; interest rate risk; taxes
rung spacing (ladder portfolios), passive fixed income portfolio management, 186
Schwab US Aggregate Bond ETF (SCHZ), 187
SCHZ (Schwab US Aggregate Bond ETF), 187
secured debt with recourse, 14
segmentation based on maturity, debt market, 2
senior debt with no recourse, 13, 13–14
senior security, convertibles, 19
7-year US Treasuries, 2
simple interest, single cash flow yield calculations, 26
simplified embedded option pricing model, 159–64, 160, 161, 162, 163, 164
single cash flow yield calculations, 25–41
actual/360 (A/360) calendar convention, 29, 30, 33, 35, 36, 37–38, 40, 41
actual/actual (A/A) calendar convention, 28, 30, 31, 34, 37, 40–41
calendar convention and, xiv, 28–31, 30, 31, 32, 33
compound interest, 26
continuous compounding, 26
daily interest, 38–39
Excel example, 31
future value (FV), 25–26, 27, 39–40
HP-12C example, 31–33
interest on interest (IOI), 26
present value (PV), 25–26, 27–28
problems, 32–41
simple interest, 26
30/360 calendar convention, 28–29, 30, 31, 33, 34, 35, 36, 37–38, 41
time (T) component and, 28–31, 30, 31, 32, 33
See also investment math
sinking funds, debt market, 9–11, 10
size of the coupon (coupon size), duration variables, 118–21, 120, 121
“soft” put option, 8
SPC (special purpose corporation), 13, 13–14
SPDR Lehman Aggregate Bond ETF (LAG), 187
special purpose corporation (SPC), 13, 13–14
speculative nature of fixed income investments, xiii
spot rates
bootstrapping the zero coupon curve, 82–85, 83, 84, 85
valuing bonds using the zero curve, 87, 88–89, 89, 89, 90
See also investment math
Standard & Poor’s, 11, 12, 156
stated returns, multiple cash flows calculations, 53, 53–54
stock (buying) and bankruptcy, pricing credit risk, 184
stocks (underperforming), convertibles, 21
stocks vs. debt market, xiii, 1, 19–21
subordinated debt, pricing credit risk, 16, 182, 182, 183, 183–84
swaps. See interest rate swaps
tactical asset allocation (automatic), convertibles, 20
targeted redemption note (TARN), debt market, 11
taxes
bond yield calculations and, 72, 75–76, 76–80, 77, 78, 79, 80
credit risk and, 152, 153–54, 164
duration variables, 118, 123, 123–24, 127
tax-free vs. taxable investments, 76–78, 77
30/360 calendar convention
multiple cash flows calculations, 46–47, 48, 49, 50, 51, 57, 62–63
single cash flow yield calculations, 28–29, 30, 31, 33, 34, 35, 36, 37–38, 41
See also calendar conventions
three ETF approach (outperforming an index strategy), 198, 200
tie the market, passive fixed income portfolio management, 185, 186–87
time discounting future cash flows, duration calculations, 111, 111–17, 112, 112, 113, 114, 115, 116, 117
time (T) component and single cash flow yield calculations, 28–31, 30, 31, 32, 33
time-weighting future cash flows, duration calculations, 107–10, 110, 111, 113, 113
total return in dollars (T–R)
bond yield calculations, 73–74, 74
duration calculations and, 102, 102–3, 103, 104, 113
interest rate risk vs. reinvestment risk, 97–98, 101–2, 113
See also investment math
total return strategy, active portfolio management, 197, 200–212, 201, 202, 202, 203, 203, 204, 205, 206, 207, 208, 209, 210, 211
total spread, credit risk, xiv, 151–52
T–R. See total return in dollars
trade obligations, debt market, 15–16
Treasuries. See US Treasuries
T (time) component and single cash flow yield calculations, 28–31, 30, 31, 32, 33
20-year US Treasuries, 2
uncertainty risk, credit risk, 152, 158–59, 164
underperforming the common, convertibles, 21
US agencies, 30, 187, 197, 198, 198, 200
US Corporates, xiv
active portfolio management, 197, 198, 198, 200
calendar conventions, 30
compounding frequencies, 54
duration variables, 123
embedded options risk, 159, 164, 165
interest rate risk vs. reinvestment risk, 113–14, 114
passive fixed income portfolio management, 187
pricing credit risk, 173, 174, 177, 178, 178–79
US Municipals, 30, 54, 198, 199, 200
US Treasuries, xiv
active portfolio management, 197, 198, 198, 199–200
calendar conventions, 30
compounding frequencies, 54
credit risk, 152, 153, 154–55, 158, 158
embedded options risk, 164, 164–65
interest rate risk vs. reinvestment risk, 116, 117, 117
pricing credit risk, 173, 177–78, 178–79
single cash flow yield calculations, 30, 38–39
valuing bonds using the zero curve, 86–93
Excel example, 89, 89, 89–90, 90
future value (FV), 87
spot rates, 87, 88–89, 89, 89, 90
yield to maturity (YTM), xiv, 88, 88, 90–92, 91, 92
See also investment math
valuing embedded options, 171, 171–72, 172
Vanguard Total Bond Market ETF (BND), 187
variables that impact duration. See duration variables
volatility impact on price, embedded options risk, 169–71, 170
work-out period, convertibles, 18–19
yield constant and convexity, 145–49, 146, 147, 148, 149
yield curve plays (total return strategy), 200, 205–11, 206, 207, 208, 209, 210, 211
yield-to-call, 72
yield to maturity (YTM)
bond yield calculations, xiv, 66–71, 70–71, 72–73, 75, 76, 76, 80
duration calculations and, 104, 104–6, 105, 106, 111, 114
duration variables, 118, 122–23, 123, 127
valuing bonds using the zero curve, xiv, 88, 88, 90–92, 91, 92
See also investment math
yield-to-put, 72
yield-to-worst, 72
YTM. See yield to maturity
ZCBs. See zero coupon bonds
zero coupon bonds (ZCBs)
bond yield calculations, 69, 70, 70–71, 74–75
bootstrapping the zero coupon curve, 82–85, 83, 84, 85
convexity (C), 144–45, 146, 146, 147, 147–49, 148, 149
defined, 6
duration calculations, 116, 116–17
duration variables, 120, 120, 124
multiple cash flows calculations, 47, 55–56, 57, 58–59
nonparallel yield curve shifts, 95, 96
passive fixed income portfolio management (fund liabilities), 185, 188
See also valuing bonds using the zero curve; zero coupon bonds (ZCBs) examples
zero coupon bonds (ZCBs) examples
active portfolio management, 206–7
passive fixed income portfolio management, 193, 193–96, 194, 195, 196
See also zero coupon bonds (ZCBs)