School of Bonds & Fixed Income Products

Day 1

Bond Analytics
Introduction to Fixed Income Securities

• What is a bond?
• Who issues and invests
• Bond characteristics
• Coupon: fixed, floating, zero coupon bonds (“strips”)
• Price/yield relationship
• The major Government bond markets
• The Eurobond market
• MTN issuance programme
• Corporate bond issuance

Yield Curves & Fixed Income Valuation

• Calculating a bond’s price on a coupon date
• Clean (quoted) v dirty price
• Common accrual conventions
• Calculating a bond’s price on a non-coupon date
• Interpreting the price: defining yield measures
• Yield to maturity as an internal rate of return (IRR)
• Yield to call
• Running yield
• The yield curve and yield curve theories
• Econometric forecasting of the yield curve

Case study: Delegates will price various fixed income instruments

Day 2

Bond Analytics
Understanding the Zero Coupon Curve

• The problem with YTMs:
• Re-investment risk
• Understanding the zero-coupon bond pricing concept and its importance in the marking-to-market process
• Constructing the zero-coupon equivalent yield curve
• The government bond “strip” curve
• Using zero-coupon discount factors in the price discovery process

Case study: Delegates will derive the zero-coupon curve and use it to value a number of instruments

Fixed Income Market Risk Analysis

• Price-yield relationship for option-free bonds
• Determinants of bond price sensitivity
• Measures of bond price sensitivity:
• Macaulay Duration
• Modified Duration
• Dollar Duration, PVBP (Present Value of a Basis Point)
• Calculation and interpretation of duration
• The non-linear properties of duration: time, yield and coupon dependencies
• Calculating the duration of a bond portfolio

Bond Simulation: Participants will use bond analytic software to understand fixed income exposures and the role convexity plays

Convexity

• Convexity defined
• Calculating convexity for fixed coupon bonds
• The implications and ‘value’ of positive & negative convexity on market yields
• Relationship between convexity and interest rate volatility
• Limitations of duration and convexity: assumptions, benefits & shortcomings

Case study: Delegates will use duration and convexity measures to determine a bond’s return in a changing yield curve environment

Day 3

Yield Pick-Up from Trading Credit: Corporate Bonds & Credit Spread Analysis
Corporate Bonds & Understanding the Spread

• Macro drives of the credit spread
• Measuring the credit spread
• Yield spread over the benchmark and I-spread
• Deriving the asset swap spread
• Par-par v yield asset swaps
• What is the Z-spread
• Asset swap spread v Z-spread
• The role of the credit default swap (CDS) in pricing new issues and relative value analysis
• Relationship between CDS, asset swap, and repo
• Understanding negative and positive CDS basis
• Which spread to use?
• Taking into account the term structure of default probabilities: “arbitrage” pricing spread

Corporate Bonds and the Rating Process

• The role of the rating agencies
• What is a rating?
• Issuer v issue ratings
• Ratings watch & outlook
• What factors drive the rating
• Empirical performance
• Default frequencies
• Rating transition tables
• Recovery rates
• The importance of sovereign ratings

Hedging Interest Rate Risk & the Credit Spread

• Hedging with government bonds and futures referenced to the government curve
• Setting up the hedge ratio
• The problem with traditional approaches
• Using CDS’s to hedge spread risk
• Portfolio hedging approaches with iTraxx contracts

Day 4

Selecting Instrument Types for Outperformance
Credit Linked Notes & Securitisation

• Creating a CLN
• The market for securitised products
• Issuance patterns pre and post the crisis
• Motivation for issuers and investors
• Building a CDO
• Balance sheet v arbitrage deals
• Cash flow v synthetic instruments
• CDS primer

Creating Value through Convertible Bond Arbitrage

• How do convertible bonds work?
• Understanding the terminology
• Establishing the arbitrage trade
• Understanding the key risk factors of a convertible arb trade
• How well has the trade worked in the past?
• Practical example of an arb trade

Inflation-Linked Bonds: Real v Nominal Returns

• Rationale for issuance
• Market size
• Mechanics explained
• US Treasury Inflation Protected Securities (TIPS)
• RSA Inflation-linked market
• Real v nominal returns

What about deflation?

• What are the (hidden) risks?
• The role of inflation linked bonds in portfolio construction

Day 5

Portfolio Management Strategies:Yield Enhancement & Trading Strategies
Trading Structured Products: Yield Enhancement with Callable Bonds

• What is a callable bond
• Investor motivation: identifying the yield enhancement
• Hedging strategies for the issuer using swaptions
• Why issue step-up callable bonds
• A generalised template for valuing bonds with embedded options
• Understanding the nature of the embedded option
• Building an arbitrage-free rate tree
• Valuing a vanilla bond using the rate tree
• Applying the technique to callable bonds
• Extending the analysis to bonds with other embedded options

Case study: Delegates will use market data to derive a “fair” valuation for a callable bond

Trading the Yield Curve to Enhance Yield

• Horizon (total return) analysis
• Calculating the total return
• Determining the exit price
• Choosing the optimal bond maturity for the trade
• Understanding the role of the forward rate
• Riding the yield curve: Using repo to generate gains

Case study: Delegates will calculate the holding period return and yield pick-upTrading Convexity

• Convexity bias and the yield curve
• Basics of convexity
• What factors influence convexity
• Volatility and the value of convexity
• Convexity, yield curve and expected returns
• Convexity bias: The impact of convexity on the curve shape
• The impact of convexity on expected bond returns
• Taking advantage of convexity: Barbell – bullet analysis

Course summary and close