Interest Rate Markets: A Practical Approach to Fixed Income (Wiley Trading)

366 Pages·2011·4.23 MB·English

by  Siddhartha Jha

P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford

i
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford
Interest Rate
Markets

i
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford
Founded in 1807, John Wiley & Sons is the oldest independent publish-
ingcompanyintheUnitedStates.WithofficesinNorthAmerica,Europe,
Australia,andAsia,Wileyisgloballycommittedtodevelopingandmarket-
ing print and electronic products and services for our customers’ profes-
sionalandpersonalknowledgeandunderstanding.
TheWileyTradingseriesfeaturesbooksbytraderswhohavesurvived
the market’s ever-changing temperament and have prospered—some by
reinventingsystems,othersbygettingbacktobasics.Whetherthereader
is a novice trader, a professional, or somewhere in between, these books
will provide the advice and strategies needed to prosper today and well
intothefuture.
For a list of available titles, visit our Web site at www.WileyFinance.com.

ii
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford
Interest Rate
Markets
A Practical Approach to
Fixed Income
SIDDHARTHA JHA

JohnWiley&Sons,Inc.
iii
P1: JYS
fm JWBT428-Jha January 13, 2011 23:4 Printer: Courier Westford
Copyright © 2011 by Siddhartha Jha. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in
any form or by any means, electronic, mechanical, photocopying, recording, scanning, or oth-
erwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act,
without either the prior written permission of the Publisher, or authorization through payment
of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive,
Danvers, MA 01923, [phone], fax [phone], or on the Web at www.copyright.com.
RequeststothePublisherforpermissionshouldbeaddressedtothePermissionsDepartment,
JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030,[phone],fax(201)748-
6008, or online at http://www.wiley.com/go/permissions.
LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheirbest
effortsinpreparingthisbook,theymakenorepresentationsorwarrantieswithrespecttothe
accuracyorcompletenessofthecontentsofthisbookandspecificallydisclaimanyimplied
warrantiesofmerchantabilityorfitnessforaparticularpurpose.Nowarrantymaybecreated
orextendedbysalesrepresentativesorwrittensalesmaterials.Theadviceandstrategiescon-
tainedhereinmaynotbesuitableforyoursituation.Youshouldconsultwithaprofessional
whereappropriate.Neitherthepublishernorauthorshallbeliableforanylossofprofitorany
othercommercialdamages,includingbutnotlimitedtospecial,incidental,consequential,or
otherdamages.
Forgeneralinformationonourotherproductsandservicesorfortechnicalsupport,please
contactourCustomerCareDepartmentwithintheUnitedStatesat(800)762-2974,outsidethe
UnitedStatesat(317)572-3993orfax(317)572-4002.
Wileyalsopublishesitsbooksinavarietyofelectronicformats.Somecontentthatappears
inprintmaynotbeavailableinelectronicbooks.FormoreinformationaboutWileyproducts,
visit our web site at www.wiley.com.
LibraryofCongressCa taloging-in-PublicationData:
Jha,Siddhartha,1984–
Interestratemarkets:apracticalapproachtofixedincome/SiddharthaJha.
p.cm.–(Wileytradingseries)
Includesbibliographicalreferencesandindex.
ISBN978-0-470-93220-9(cloth);ISBN978-1-118-01777-7(ebk);
ISBN978-1-118-01778-4(ebk);ISBN978-1-118-01779-1(ebk)
1.Interestrates. 2.Fixed-incomesecurities. 3.Bonds. I.Title.
HG1621.J432011
332.63(cid:1)2044–dc22
2010043312
PrintedintheUnitedStatesofAmerica
10 9 8 7 6 5 4 3 2 1
iv
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford
Tomyparents

v
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford

vi
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford
Contents
Acknowledgments xiii
Introduction xv
CHAPTER 1 Tools of the Trade 1
BasicStatistics 2
Regression:TheFundamentals 6
Regression:HowGoodaFit? 11
PrincipalComponentsAnalysis 14
ScalingthroughTime 15
BacktestingStrategies 16
Summary 17
CHAPTER 2 Bonds 19
BasicsofBonds 19
RisksEmbeddedinFixedIncomeInstruments 22

Discounting 27
BondPricing 28
YieldCurve 32
Duration 34
Convexity 37
RepoMarkets 42
BidOffer 44
CalculatingProfit/LossofaBond 45
Carry 45
vii
P1:JYS
fm JWBT428-Jha January13,2011 23:4 Printer:CourierWestford
viii CONTENTS
ForwardRates 47
Rolldown/Slide 51
CurvesandSpreads 53
ButterflyTrades 55
Summary 56
CHAPTER 3 Fixed Income Markets 59
FederalReserve 60
Treasuries 67
STRIPS 70
TIPS 71
Mortgages 73
AgencyDebt 77
CorporateBonds 79
MunicipalBonds 82
Summary 84
CHAPTER 4 Interest Rate Futures 85
BasicsofFuturesTransactions 86
EurodollarFutures 89
Convexity(orFinancing)Bias 92
CreatingLonger-DatedAssetsUsing
EurodollarFutures 93
TreasuryFutures 94
FedFundsFutures 101

FuturesPositioningData 104
Summary 105
CHAPTER 5 Interest Rate Swaps 107
BasicPrinciples 108
DurationandConvexity 111
UsesofSwaps 112
CounterpartyRisk 115
OtherTypesofSwaps 115
Summary 124