Pricing and Hedging Interest and Credit Risk Sensitive Instruments


  • Frank Skinner, Reader in Finance, ISMA Centre, University of Reading, UK.

This book is tightly focused on the pricing and hedging of fixed income securities and their derivatives. It is targeted at those who are interested in trading these instruments in an investment bank, but is also useful for those responsible for monitoring compliance of the traders such as regulators, back office staff, middle and senior lever managers. To broaden its appeal, this book lowers the barriers to learning by keeping math to a minimum and by illustrating concepts through detailed numerical examples using Excel workbooks/spreadsheets on a CD with the book. On the accompanying CD with the book, three interest rate models are illustrated: Ho and Lee, constant volatility and Black Derman and Toy, along with two evolutionary models, Vasicek and CIR and two credit risk models, Jarrow and Turnbull and Duffie and Singleton. These are implemented via spreadsheets on the CD.
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Traders in fixed income products and their derivatives; Back office staff; Middle managers who are interested in catching up on what has been happening in the fixed income area over the last decade; and regulators and auditors who are responsible for monitoring investment bank activity.


Book information

  • Published: October 2004
  • ISBN: 978-0-7506-6259-8

Table of Contents

An Introduction to Interest Rate and Credit Sensitive Instruments: Bond conventions; Bond markets; Trends in the global capital markets; Corporate bonds; Scope of this book; Exercises; The Sovereign Term Structure and the Risk Structure of Interest Rates: Objectives-pricing and hedging; Introduction to the term and credit risk structure of interest rates; The uses of the term structure and risk structure of interest rates; Theories of the sovereign term structure of interest rates; Theory of the risk structure of interest rates; How sovereign bonds are issued; Repos; Summary; Exercises; Measuring the Existing Sovereign Term Structure and the Risk Structure of Interest Rates: Measuring the sovereign term structure of interest rates; Frequently traded bonds; Zero coupon yields; Measuring continuous yield curves; Par coupon yield curves; Summary; Exercises; Modelling the Sovereign Term Structure of Interest Rates: The Binomial Approach The binomial approach; The simple model; Which short rate of interest should we model?; Pricing a bond using the interest rate tree; The problems with the simple model; Incorporating risk aversion; Exercises; Interest Rate Modelling: The term structure consistent approach Desirable features of an interest rate model; Ho and Lee (1986); Black Derman and Toy: Constant volatility; Black Derman and Toy (1990); Some other one-factor term structure consistent models; Summary; Exercises; Interest and Credit Risk Modelling: Evolutionary interest rate models; Vasicek (1977); Cox Ingersoll and Ross (1985); Other evolutionary models; Comparing the term structure consistent and evolutionary models; The problem with interest rate (and credit risk) models; Non-stochastic credit risk models; Jarrow and Turnbull (1995); Duffie and Singleton (1999); Other credit risk modelling approaches; Summary; Exercises; Hedging Sovereign Bonds: The Traditional Approach Introduction; Macaulay Duration; Modified duration; Other measures of interest rate sensitivity; Convexity; Hedging; Regression based hedge ratios; Duration based hedge ratio; Basis risk; Appendix; Exercises; Active and Passive Strategies: Introduction; Adjusting the duration of a portfolio; Active and passive strategies; Implementing a rate anticipation swap; Implementing an asset substitution swap; Portfolio immunisation; Balance sheet immunisation; Bond portfolio management; Exercises; Alternative Hedge Ratios: Improvements in modified duration hedge ratios; Fisher Weil; Key rate durations; Duration for corporate bonds; Delta hedging; Exercises; Pricing and Hedging Non-Fixed Income Securities: Introduction; Floaters; Inverse floaters; Caps floors and collars; Interest rate swaps; Exercises; Credit Derivatives: Introduction; Types of credit derivatives; Vulnerable derivatives; Credit default swaps; Issues in default swap pricing; Exercises; Embedded Options: Introduction; An introduction to callable/putable bonds; Measures of interest rate sensitivity for callable bonds; Sinking fund bonds; Exercises.