Description
Book SynopsisHow to build a framework for forecasting interest rate market movements With trillions of dollars worth of trades conducted every year in everything from U.S. Treasury bonds to mortgage-backed securities, the U.S. interest rate market is one of the largest fixed income markets in the world.
Table of ContentsAcknowledgments xiii
Introduction xv
CHAPTER 1 Tools of the Trade 1
Basic Statistics 2
Regression: The Fundamentals 6
Regression: How Good a Fit? 11
Principal Components Analysis 14
Scaling through Time 15
Backtesting Strategies 16
Summary 17
CHAPTER 2 Bonds 19
Basics of Bonds 19
Risks Embedded in Fixed Income Instruments 22
Discounting 27
Bond Pricing 28
Yield Curve 32
Duration 34
Convexity 37
Repo Markets 42
Bid Offer 44
Calculating Profit/Loss of a Bond 45
Carry 45
Forward Rates 47
Rolldown/Slide 51
Curves and Spreads 53
Butterfly Trades 55
Summary 56
CHAPTER 3 Fixed Income Markets 59
Federal Reserve 60
Treasuries 67
Strips 70
Tips 71
Mortgages 73
Agency Debt 77
Corporate Bonds 79
Municipal Bonds 82
Summary 84
CHAPTER 4 Interest Rate Futures 85
Basics of Futures Transactions 86
Eurodollar Futures 89
Convexity (or Financing) Bias 92
Creating Longer-Dated Assets Using Eurodollar Futures 93
Treasury Futures 94
Fed Funds Futures 101
Futures Positioning Data 104
Summary 105
CHAPTER 5 Interest Rate Swaps 107
Basic Principles 108
Duration and Convexity 111
Uses of Swaps 112
Counterparty Risk 115
Other Types of Swaps 115
Summary 124
CHAPTER 6 Understanding Drivers of Interest Rates 125
Supply and Demand for Borrowing 126
Components of Fixed Income Supply and Demand 141
Treasury Supply 141
Other Sources of Fixed Income Supply 145
Fixed Income Demand 148
Short-Term Yield Drivers 157
Summary 172
CHAPTER 7 Carry and Relative Value Trades 173
Carry Trades 173
Carry Trade Setup and Evaluation 175
Pitfalls of the Carry Trade 178
Carry-Efficient Directional Trades 182
Relative Value Trades 183
Setting Up Relative Value Trades 185
Treasury Bond Relative Value—Par Curve 191
Other Treasury Relative Value Trades 193
Summary 194
CHAPTER 8 Hedging Risks in Interest Rate Products 197
Principles of Hedging 198
Choices of Instruments for Hedging 202
Calculating Hedge Ratios 210
Yield Betas 215
Convexity Hedging 218
Summary 223
CHAPTER 9 Trading Swap Spreads 225
How Swap Spreads Work 225
Why Trade Swap Spreads? 230
Directionality of Swap Spreads to Yields 240
Futures Asset Swaps 241
Spread Curve Trades 243
Summary 245
CHAPTER 10 Interest Rate Options and Trading Volatility 247
Option Pricing and Fundamentals 249
Modifications for the Interest Rate Markets 254
Quoting Volatility 256
Measuring Risks in Option Positions 257
Put/Call Parity 266
Implied and Realized Volatility 268
Skew 270
Delta Hedging 270
Interest Rate Options 275
Embedded Options and Hedging 280
More Exotic Structures 283
Yield Curve Spread Options 284
Forward Volatility 285
Volatility Trading 286
Interest Rate Skew 293
Volatility Spread Trades 294
Caps versus Swaptions 297
Summary 298
CHAPTER 11 Treasury Futures Basis and Rolls 299
The Futures Delivery Option 299
Calculating the Delivery Option Value 309
Option-Adjusted and Empirical Duration 311
Treasury Futures Rolls 313
Summary 318
CHAPTER 12 Conditional Trades 319
Conditional Curve Trades 320
Conditional Spread Trades 324
Summary 328
References 329
About the Author 331
About the Web Site 333
Index 335
