Interest Rate Risk Modeling: The Fixed Income Valuation Course / Edition 1

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The importance of managing interest rate risk cannot be overstated.The explosive growth of interest rate swaps over the last quartercentury is a telling sign that financial institutions and othermarket participants are concerned about the risk interest ratespose. Yet there is no easy way to address this issue. Thisbook—the first of three in the Fixed Income ValuationCourse—seeks to improve the current information available oninterest rate risk, and upgrade your understanding of how tomeasure and manage it.

Written by fixed income specialists Sanjay Nawalkha, GloriaSoto, and Natalia Beliaeva, Interest Rate Risk Modeling offers adetailed introduction to the various modeling techniques used bytoday's fixed income professionals. Whether you're measuring thenon-parallel durations of a naked call option, adjusting thenotional amounts in swaps and caps using the LIBOR market model, orcomputing the durations of default-prone bonds using thecutting-edge first-passage probability models, this book has whatyou need to succeed in a volatile interest rate environment. Itexamines the latest innovations in the area of interest rate riskmanagement and provides a detailed look at the most widely usedmodels in this field, including duration, convexity, M-absolute,M-square, duration vector, key rate durations, principal componentdurations, and others.

Interest Rate Risk Modeling also illustrates the applications ofthese models to regular bonds, callable bonds, T-Bill futures,T-Bond futures, Eurodollar futures, interest rate swaps, forwardrate agreements, bond options, yield options (caps, floors, andcollars), swaptions, mortgage-backed securities, and default-pronecoupon bonds.

Accompanying the authors' in-depth insights and practical advicefound within these pages is an information-packed CD-ROM that canshow a term structure "movie" or estimate yield curves in seconds,in addition to solving the advanced risk management models. Thiselectronic companion contains Excel®/VBA® spreadsheetsfor hands-on analysis, using various models presented in the book.Through a user-friendly format, these spreadsheets computenon-parallel interest rate risk measures for a variety of interestrate derivatives, and can implement passive portfolio strategies,such as immunization and index replication, or speculativestrategies based upon expected yield curve movements.

Whether you are a manager of a pension bond fund, a manager ofGICs at an insurance company, an analyst at a speculative hedgefund, or a VP at a commercial bank, if you want to excel atmeasuring and managing interest rate risk, you have to understandhow to model it. Interest Rate Risk Modeling can show you how.

For more information on the three books in this course,including demo software and special features, please

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Product Details

  • ISBN-13: 9780471427247
  • Publisher: Wiley
  • Publication date: 4/22/2005
  • Series: Wiley Finance Series, #178
  • Edition description: Includes CD-ROM
  • Edition number: 1
  • Pages: 396
  • Product dimensions: 6.20 (w) x 9.10 (h) x 1.50 (d)

Meet the Author

Sanjay K. Nawalkha, PhD, is Associate Professor of Financeat the University of Massachusetts Amherst, where he teachesgraduate courses in finance theory and fixed income. He haspublished extensively in academic and practitioner journals,especially in the areas of fixed income and asset pricing. He isthe coeditor of the book Interest Rate Risk Measurement andManagement, published by Institutional Investor. Dr. Nawalkha isalso the President and founder of Nawalkha and Associates.

Gloria M. Soto, PhD, is Professor of Applied Economicsand Finance at the University of Murcia, Spain. Dr. Soto haspublished extensively in both Spanish and international journals infinance, especially in the areas of interest rate risk managementand related fixed income topics. She is also a partner at Nawalkhaand Associates.

Natalia A. Beliaeva holds an MS in computer science(artificial intelligence) and expects to receive her PhD in financefrom the University of Massachusetts Amherst in 2005. Ms.Beliaeva's expertise is in the area of applied numerical methodsfor pricing fixed income derivatives.

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Table of Contents

List of Figures.

List of Tables.

Chapter 1: Interest Rate Risk Modeling: An Overview.

Duration and Convexity Models.

M-Absolute and M-Square Models.

Duration Vector Models.

Key Rate Duration Models.

Principal Component Duration Models.

Applications to Financial Institutions.

Interaction with Other Risks.


Chapter 2: Bond Price, Duration, and Convexity.

Bond Price under Continuous Compounding.



Common Fallacies Concerning Duration and Convexity.

Formulas for Duration and Convexity.

Appendix 2.1: Other Fallacies Concerning Duration andConvexity.


Chapter 3: Estimation of the Term Structure of InterestRates.

Bond Prices, Spot Rates, and Forward Rates.

Term Structure Estimation: The Basic Methods.

Advance Methods in Term Structure Estimation.


Chapter 4: M-Absolute and M-Square Risk Measures.

Measuring Term Structure Shifts.

M-Absolute versus Duration.

M-Square versus Convexity.

Closed-Form Solutions for M-Square and M-Absolute.

Appendix 4.1: Derivation of the M-Absolute and M-SquareModels.

Appendix 4.2: Two-Term Taylor-Series-Expansion Approach to theM-Square Model.


Chapter 5: Duration Vector Models.

The Duration Vector Model.

Generalized Duration Vector Models.

Appendix 5.1: Derivation of the Generalized Duration VectorModels.


Chapter 6: Hedging with Interest-Rate Futures.

Eurodollar Futures.

Treasury Bill Futures.

Treasury Bond Futures.

Treasury Note Futures.

Appendix 6.1: The Duration Vector of the Eurodollar Futures.

Appendix 6.2: The Duration Vector of the T-Bond Futures.


Chapter 7: Hedging with Bond Options: A General GaussianFramework.

A General Gaussian Framework for Pricing Zero-Coupon BondOptions.

The Duration Vectors of Bond Options.

The Duration Vector of Callable Bonds.

Estimation of Duration Vectors Using Non-Gaussian Term StructureModels.

The Durations of European Options on Coupon Bonds and CallableCoupon Bonds.

Chapter 8: Hedging with Swaps and Interest Rate Options Usingthe LIBOR Market Model.

A Simple Introduction to Interest Rate Swaps.

Motivations for Interest Rate Swaps.

Pricing and Hedging with Interest Rate Swaps.

Forward Rate Agreements.

Pricing and Hedging with Caps, Floors, and Collars Using theLIBOR Market Model.

Interest Rate Swaptions.

Numerical Analysis.


Chapter 9: Key Rate Durations with VaR Analysis.

Key Rate Changes.

Key Rate Durations and Convexities.

Risk Measurement and Management.

Key Rate Durations and Value at Risk Analysis.

Limitations of the Key Rate Model.

Appendix 9.1: Computing Key Rate Risk Measures for ComplexSecurities and under Maturity Mismatches.


Chapter 10: Principal Component Model with VaRAnalysis.

From Term Structure Movements to Principal Components.

Principal Component Durations and Convexities.

Risk Measurement and Management with the Principal ComponentModel.

VaR Analysis Using the Principal Component Model.

Limitations of the Principal Component Model.

Applications to Mortgage Securities.

Appendix 10.1: Eigenvectors, Eigenvalues, and PrincipalComponents.

Appendix 10.2: Computing Principal Component Risk Measures forComplex Securities and under Maturity Mismatches.


Chapter 11: Duration Models for Default-ProneSecurities.

Pricing and Duration of a Default-Free Zero-Coupon Bond underthe Vasicek Model.

The Asset Duration.

Pricing and Duration of a Default-Prone Zero-Coupon Bond: TheMerton Framework.

Pricing and Duration of a Default-Prone Coupon Bond: The FirstPassage Models.

Appendix 11.1: Collin-Dufresne and Goldstein Model.



About the CD-ROM.


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