Management of Bond Investments and Trading of Debt (eBook)

Cover 1
Copyright Page 5
TOC$Contents 6
Preface 12
Part 1: The dynamics of debt, leverage, and globalization 16
CH$Chapter 1. Democratization of lending and socialization of risk 18
1.1 Introduction 18
1.2 The shift in economic activity 19
1.3 Creativity, innovation, and tax incentives 23
1.4 Debt and unsustainable leverage 26
1.5 Leverage, common risk, and strategic risk 29
1.6 Debt management challenges 33
1.7 Controlling the speed limit of an economy 35
CH$Chapter 2. Trading debt in a globalized economy 40
2.1 Introduction 40
2.2 Forces propelling economic growth 42
2.3 Capital flows and impact of globalization on economic development 45
2.4 The macro-dimension of financial markets 48
2.5 Upside and downside of hedging 51
2.6 Wealth creation requires an open and transparent financial market 54
2.7 Mercantilism is not a good strategy in an economy of mounting debt 58
Part 2: The bondholder’s options, risks, and rewards 62
CH$Chapter 3. Bonds defined 64
3.1 Introduction 64
3.2 An introduction to types of bonds 66
3.3 Markets and issuers of bonds 69
3.4 Bond market and equity market 74
3.5 Yield of fixed income instruments and the ECB model 77
3.6 Credit spread risk and other risks 79
3.7 A bird’s-eye view of foreign exchange risk 82
3.8 Bond restructuring and arbitrage 85
Appendix 3. A The ECB algorithm 88
CH$Chapter 4. Convertible bonds, zero bonds, junk bonds, strips, and other bonds 90
4.1 Introduction 90
4.2 Straight and callable bonds 91
4.3 Zero-coupon bonds 94
4.4 Convertible bonds 97
4.5 The Bloomberg model for portfolio value-at-risk 98
4.6 Junk bonds and credit derivatives 100
4.7 High-high risk bonds 102
4.8 The stripping of bonds 103
4.9 Brady bonds and Rubin bonds 105
4.10 Chameleon bonds, Samurai bonds, and unwanted consequences 107
CH$Chapter 5. Choosing bonds 110
5.1 Introduction 110
5.2 Investors can never be too careful 111
5.3 Price formation for bonds 115
5.4 Euroland and lessons from Eurodollars 118
5.5 Euroland and bond market compliance 120
5.6 Return on capital for bondholders 123
5.7 Disincentives in holding bonds 126
5.8 Taxation and debt instruments 128
5.9 The camel is a horse designed by a committee 130
CH$Chapter 6. Bank loans and securitization 134
6.1 Introduction 134
6.2 Determination of bank lending rates 136
6.3 Panics and their aftermath 140
6.4 China’s credit policies: a case study 142
6.5 Bank regulation and risk control 144
6.6 The confirmation of Basel II 148
6.7 An introduction to securitization 150
6.8 Securitization as a mechanism for risk transfer? 152
6.9 A bridge too far in democratization of lending 154
Part 3: Interest rates, yields, and duration 158
CH$Chapter 7. The dynamics of interest rates 160
7.1 Introduction 160
7.2 Who sets interest rates? 161
7.3 Effect of interest rate hikes on the market 165
7.4 Interest rates, net asset value, and present value 167
7.5 What’s the purpose of rock-bottom interest rates? 171
7.6 The shape of interest rate curves 175
7.7 Modeling the volatility of interest rate premium 179
CH$Chapter 8. Inflation indexing and impact of government deficits 183
8.1 Introduction 183
8.2 Money is merchandise with great leveraging 184
8.3 Who pays for the shortfall in interest rates? 188
8.4 Convergence and divergence in inflationary patterns 191
8.5 An important BIS study on deflation 193
8.6 Debt financing by the public sector 196
8.7 Government borrowing, money supply, and interest rates 199
8.8 Inflation-indexed securities 202
8.9 Choices necessary to overcome accounting insufficiency 205
Appendix 8.A The Deutsche Bundesbank algorithm 207
CH$Chapter 9. Bond yields and benchmark government bonds 209
9.1 Introduction 209
9.2 Algorithms for computation of yield 210
9.3 Yield estimates, basis points, and yield curves 214
9.4 Nominal, real, and natural interest rates, and inflation-indexing 218
9.5 Fisher parity of nominal and real interest rates 222
9.6 US Treasuries as benchmarks, futures, and forwards trading 225
9.7 The Federal Open Market Committee, Fed funds rate, and discount rate 227
Appendix 9.A Yield of fixed interest bonds, with annual interest payment and maturity in n years 231
Appendix 9.B Yield of fixed interest bonds: an alternative computational procedure based on cash flow 232
Appendix 9.C Fisher parity algorithm linking nominal and real interest rates 234
Appendix 9.D The ISMA algorithm for narrowly defined effective rate 234
Appendix 9.E Brief list of symbols frequently used in Chapters 7, 8, and 9 235
CH$Chapter 10. Maturity and duration 236
10.1 Introduction 236
10.2 Duration defined 238
10.3 Modified duration and price sensitivity 240
10.4 Macaulay’s duration algorithm 242
10.5 Results obtained with duration versus maturity 245
10.6 Practical applications of duration and convexity 247
Appendix 10.A Macaulay’s algorithm for calculating duration of a fixed rate instrument 251
Appendix 10.B Present value approach to computation of duration 252
Appendix 10.C Modified duration and effective duration 252
Appendix 10.D A duration algorithm accounting for purchase price of the bond 253
Appendix 10.E Concavity and convexity 253
Part 4: Bonds, bond markets, credit rating, and risk control 256
CH$Chapter 11. Bonds, money markets, capital markets, and financial organizations 258
11.1 Introduction 258
11.2 Growth of the bond market 261
11.3 Importance of the money market 264
11.4 Importance of the capital market 267
11.5 Capital allocation in fixed income instruments 270
11.6 The biggest assets of a bank: a management perspective 272
11.7 Need for forward planning and decisive action 277
CH$Chapter 12. Credit quality and independent rating agencies 282
12.1 Introduction 282
12.2 Independent credit rating agencies 284
12.3 Main players in credit rating in the global market 287
12.4 Credit assessment, credit monitoring, and asymmetry of information 290
12.5 The process of bond rating 294
12.6 A frame of reference for loans quality and creditworthiness 297
12.7 Risk-adjusted return on capital 300
Appendix 12.A An algorithm linking prime rate, higher up rates, and the acid test 303
CH$Chapter 13. Case studies on credit quality 305
13.1 Introduction 305
13.2 Large financial institutions and their assets 306
13.3 Bank failures: the case of Penn Square 309
13.4 Commercial paper turning to ashes: the case of Penn Central 311
13.5 The bankruptcy of Asia Pulp & Paper
13.6 Banks can be light-hearted in evaluating credit risk 316
13.7 A case of creditworthiness: investing in oil companies and their oil reserves 318
CH$Chapter 14. Market risk with bonds 323
14.1 Introduction 323
14.2 A broader view of market risk 324
14.3 Interest rate bubbles and bond market meltdown 327
14.4 Measuring exposure to interest rate risk 330
14.5 Reporting to regulators: an example from the Office of Thrift Supervision 332
14.6 Risk points and exposure patterns 334
14.7 Broadening interest rate exposure and mismatch risk 337
14.8 Hedging interest rate risk in a commercial bank 340
14.9 Stress testing for interest rate and forex risk, according to the Basel Committee 342
Appendix 14.A The Basel Committee’s approach to control of interest rate risk and optionality 345
CH$Chapter 15. The control of risk under Basel II 348
15.1 Introduction 348
15.2 Risk management defined 350
15.3 Basel II requirements for financial analysis and business analysis 353
15.4 Enterprise risk management and internal control 357
15.5 Risks investors take with asset managers 360
15.6 The cost of legal risk and reputational risk 363
15.7 Operational risk with trusteeship, mutual funds, and hedge funds 366
15.8 White collar crime hits stakeholders hard 368
IDX$Index 372