Bond Math: The Theory Behind the Formulas / Edition 1

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Filled with in-depth insights and practical advice, Bond Math covers in concise detail the key calculations finance veterans, as well as aspiring professionals, need to succeed in this field. Engaging and informative, this book is much more than just a guide to bond calculations—it skillfully emphasizes how to think about bond math and reveals which numbers are most useful when dealing with bonds.

Throughout these pages, author Donald J. Smith—an Associate Professor of Finance at Boston University's School of Management, who has been actively involved with executive education for over twenty-five years—covers many essential issues. You'll quickly become familiar with everything from money market add-on and discount rates, periodicity conversions, yields to maturity, horizon yields, implied probability of default, and after-tax rates of return to implied spot and forward rates, duration, and convexity. You'll see how these figures are used with traditional fixed-rate and zero-coupon bonds, as well as floating-rate notes (floaters), inflation-indexed securities (linkers), and interest rate swaps.

This reliable resource puts bond math in perspective, analyzing the circumstances when statistics reported for individual securities can be used to calculate summary statistics for a portfolio of bonds. It also discusses how bond math is used in both aggressive and passive investment strategies, such as taking a view on the yield curve and immunizing the portfolio from interest rate volatility.

If you work in fixed income and use Bloomberg pages to access data on bonds, you need Bond Math.

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Product Details

  • ISBN-13: 9781576603062
  • Publisher: Wiley
  • Publication date: 7/26/2011
  • Series: Wiley Finance Series , #106
  • Edition number: 1
  • Pages: 288
  • Sales rank: 1,467,277
  • Product dimensions: 6.20 (w) x 9.10 (h) x 1.10 (d)

Meet the Author

Donald J. Smith is an award-winning professor at Boston University, where he teaches graduate-level courses on fixed income markets, as well as executive education courses. Professor Smith also consults to commercial and investment banks, financial firms, and law firms. He has written numerous articles for various academic and professional journals, and received his MBA and PhD from the University of California, Berkeley.

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Table of Contents

Preface xi

CHAPTER 1: MoneyMarket Interest Rates 1

Interest Rates in Textbook Theory 2

Money Market Add-on Rates 3

Money Market Discount Rates 6

Two Cash Flows, Many Money Market Rates 9

A History Lesson on Money Market Certificates 12

Periodicity Conversions 13

Treasury Bill Auction Results 15

The Future: Hourly Interest Rates? 20

Conclusion 22

CHAPTER 2: Zero-Coupon Bonds 23

The Story of TIGRS, CATS, LIONS, and STRIPS 24

Yields to Maturity on Zero-Coupon Bonds 27

Horizon Yields and Holding-Period Rates of Return 30

Changes in Bond Prices and Yields 33

Credit Spreads and the Implied Probability of Default 35

Conclusion 38

CHAPTER 3: Prices and Yields on Coupon Bonds 39

Market Demand and Supply 40

Bond Prices and Yields to Maturity in a World of No Arbitrage 44

Some Other Yield Statistics 49

Horizon Yields 53

Some Uses of Yield-to-Maturity Statistics 55

Implied Probability of Default on Coupon Bonds 56

Bond Pricing between Coupon Dates 57

A Real Corporate Bond 60

Conclusion 63

CHAPTER 4: Bond Taxation 65

Basic Bond Taxation 66

Market Discount Bonds 68

A Real Market Discount Corporate Bond 70

Premium Bonds 74

Original Issue Discount Bonds 77

Municipal Bonds 79

Conclusion 82

CHAPTER 5: Yield Curves 83

An Intuitive Forward Curve 84

Classic Theories of the Term Structure of Interest Rates 86

Accurate Implied Forward Rates 91

Money Market Implied Forward Rates 93

Calculating and Using Implied Spot (Zero-Coupon) Rates 96

More Applications for the Implied Spot and Forward Curves 99

Conclusion 105

CHAPTER 6: Duration and Convexity 107

Yield Duration and Convexity Relationships 108

Yield Duration 111

The Relationship between Yield Duration and Maturity 115

Yield Convexity 118

Bloomberg Yield Duration and Convexity 122

Curve Duration and Convexity 127

Conclusion 135

CHAPTER 7: Floaters and Linkers 137

Floating-Rate Notes in General 138

A Simple Floater Valuation Model 139

An Actual Floater 143

Inflation-Indexed Bonds: C-Linkers and P-Linkers 149

Linker Taxation 153

Linker Duration 156

Conclusion 161

CHAPTER 8: Interest Rate Swaps 163

Pricing an Interest Rate Swap 164

Interest Rate Forwards and Futures 168

Inferring the Forward Curve 170

Valuing an Interest Rate Swap 174

Interest Rate Swap Duration and Convexity 179

Conclusion 184

CHAPTER 9: Bond Portfolios 185

Bond Portfolio Statistics in Theory 185

Bond Portfolio Statistics in Practice 189

A Real Bond Portfolio 194

Thoughts on Bond Portfolio Statistics 206

Conclusion 207

CHAPTER 10: Bond Strategies 209

Acting on a Rate View 211

An Interest Rate Swap Overlay Strategy 215

Classic Immunization Theory 218

Immunization Implementation Issues 224

Liability-Driven Investing 226

Closing Thoughts: Target-Duration Bond Funds 227

Technical Appendix 231

Acronyms 249

Bibliographic Notes 251

About the Author 257

Acknowledgments 259

Index 261

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