Fixed Income Analysis

768 Pages·2007·8.55 MB·English

by  Frank J. Fabozzi CFA

FIXED INCOME
ANALYSIS
Second Edition
Frank J. Fabozzi, PhD, CFA, CPA
withcontributionsfrom
MarkJ.P. Anson,PhD, CFA,CPA, Esq.
KennethB. Dunn,PhD
J.HankLynch,CFA
JackMalvey, CFA
MarkPitts, PhD
ShrikantRamamurthy
RobertoM. Sella
ChristopherB.Steward, CFA
John Wiley & Sons, Inc.

FIXED INCOME
ANALYSIS
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FIXED INCOME
ANALYSIS
Second Edition
Frank J. Fabozzi, PhD, CFA, CPA
withcontributionsfrom
MarkJ.P. Anson,PhD, CFA,CPA, Esq.
KennethB. Dunn,PhD
J.HankLynch,CFA
JackMalvey, CFA
MarkPitts, PhD
ShrikantRamamurthy
RobertoM. Sella
ChristopherB.Steward, CFA
John Wiley & Sons, Inc.
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LibraryofCongressCataloging-in-PublicationData:
Fabozzi,FrankJ.
Fixedincomeanalysis/FrankJ.Fabozzi.—2nded.
p.cm.—(CFAInstituteinvestmentseries)
Originallypublishedas:Fixedincomeanalysisforthecharteredfinancial
analystprogram.NewHope,Pa.:F.J.FabozziAssociates,c2000.
Includesindex.
ISBN-13:978-0-470-05221-1(cloth)
ISBN-10:0-470-05221-X(cloth)
1.Fixed-incomesecurities. I.Fabozzi,FrankJ.Fixedincomeanalysisfor
thecharteredfinancialanalystprogram.2006.II.Title.
HG4650.F3292006
332.63’23—dc22
2006052818
PrintedintheUnitedStatesofAmerica.
10987654321
CONTENTS
Foreword xiii
Acknowledgments xvii
Introduction xxi
Note onRoundingDifferences xxvii
CHAPTER1
FeaturesofDebtSecurities 1
I. Introduction 1
II. IndentureandCovenants 2
III. Maturity 2
IV. ParValue 3
V. CouponRate 4
VI. ProvisionsforPayingOffBonds 8
VII. ConversionPrivilege 13
VIII.PutProvision 13
IX. CurrencyDenomination 13
X. EmbeddedOptions 14
XI. BorrowingFundstoPurchaseBonds 15
CHAPTER2
RisksAssociatedwithInvestinginBonds 17
I. Introduction 17
II. InterestRateRisk 17
III. YieldCurveRisk 23
IV. CallandPrepaymentRisk 26
V. ReinvestmentRisk 27
VI. CreditRisk 28
VII. LiquidityRisk 32
VIII.ExchangeRateorCurrencyRisk 33
IX. InflationorPurchasingPowerRisk 34
X. VolatilityRisk 34
v
vi Contents
XI. EventRisk 35
XII. SovereignRisk 36
CHAPTER3
OverviewofBondSectorsandInstruments 37
I. Introduction 37
II. SectorsoftheBondMarket 37
III. SovereignBonds 39
IV. Semi-Government/AgencyBonds 44
V. StateandLocalGovernments 53
VI. CorporateDebtSecurities 56
VII. Asset-BackedSecurities 67
VIII.CollateralizedDebtObligations 69
IX. PrimaryMarketandSecondaryMarketforBonds 70
CHAPTER4
UnderstandingYieldSpreads 74
I. Introduction 74
II. InterestRateDetermination 74
III. U.S.TreasuryRates 75
IV. YieldsonNon-TreasurySecurities 82
V. Non-U.S.InterestRates 90
VI. SwapSpreads 92
CHAPTER5
IntroductiontotheValuationofDebtSecurities 97
I. Introduction 97
II. GeneralPrinciplesofValuation 97
III. TraditionalApproachtoValuation 109
IV. TheArbitrage-FreeValuationApproach 110
V. ValuationModels 117
CHAPTER6
YieldMeasures,SpotRates,andForwardRates 119
I. Introduction 119
II. SourcesofReturn 119
III. TraditionalYieldMeasures 120
IV. TheoreticalSpotRates 135
V. ForwardRates 147
CHAPTER7
IntroductiontotheMeasurementofInterestRateRisk 157
I. Introduction 157
II. TheFullValuationApproach 157
Contents vii
III. PriceVolatilityCharacteristicsofBonds 160
IV. Duration 168
V. ConvexityAdjustment 180
VI. PriceValueofaBasisPoint 182
VII. TheImportanceofYieldVolatility 183
CHAPTER8
TermStructureandVolatilityofInterestRates 185
I. Introduction 185
II. HistoricalLookattheTreasuryYieldCurve 186
III. TreasuryReturnsResultingfromYieldCurveMovements 189
IV. ConstructingtheTheoreticalSpotRateCurveforTreasuries 190
V. TheSwapCurve(LIBORCurve) 193
VI. ExpectationsTheoriesoftheTermStructureofInterestRates 196
VII. MeasuringYieldCurveRisk 204
VIII.YieldVolatilityandMeasurement 207
CHAPTER9
ValuingBondswithEmbeddedOptions 215
I. Introduction 215
II. ElementsofaBondValuationModel 215
III. OverviewoftheBondValuationProcess 218
IV. ReviewofHowtoValueanOption-FreeBond 225
V. ValuingaBondwithanEmbeddedOptionUsingtheBinomialModel 226
VI. ValuingandAnalyzingaCallableBond 233
VII. ValuingaPutableBond 240
VIII.ValuingaStep-UpCallableNote 243
IX. ValuingaCappedFloater 244
X. AnalysisofConvertibleBonds 247
CHAPTER10
Mortgage-BackedSectoroftheBondMarket 256
I. Introduction 256
II. ResidentialMortgageLoans 257
III. MortgagePassthroughSecurities 260
IV. CollateralizedMortgageObligations 273
V. StrippedMortgage-BackedSecurities 294
VI. NonagencyResidentialMortgage-BackedSecurities 296
VII. CommercialMortgage-BackedSecurities 298
CHAPTER11
Asset-BackedSectoroftheBondMarket 302
I. Introduction 302
II. TheSecuritizationProcessandFeaturesofABS 303