Fixed-income markets

Note that the impact of this correlation effect is not in contradiction to the results found by Bakshi, Cao and Chen [5], Nandi [62] and Schobel and Zhu [69] for equity options. They found higher option prices given positive correlations and vice verca. On the other hand, we have a risk-neutral bond price process, where the source of uncertainty is negatively assigned (see e.g. (7.2)). Thus, assuming a USV bond model with negative correlated Brownian motions is the fixed income market analog of a stochastic volatility equity market model, with positive correlated sources of uncertainty. ... 

CoUin-Dufiesne P, Goldstein R (2002) Do Bonds Span the Fixed-Income Markets Theory and Evidence for Unspanned Stochastic Volatility. Journal of Finance 57 1685-1730. 

Choudhiy, M., Moskovic, D., Wong, M., 2014. Fixed Income Markets Management, Trading and Hedging, second ed. lohn Wiley Sons, Singaptne. 

Sundaresan, S., 2009. Fixed Income Markets and Their Derivates, third ed. Elsevier, Burlington. Waggoner, D., 1997. Spline methods for extracting interest rate curves from coupon bond prices. 

Sundaresan, S., 2009. Fixed Income Markets and TTieir Derivates, third ed. Elsevier. 

While our illustrations assume that the timing of the cash flows for both the fixed-rate payer and floating-rate payer will be the same, this is rarely the case in a swap. An agreement may call for the fixed-rate payer to make payments annually but the floating-rate payer to make payments more frequently (semi-annually or quarterly). Also, the way in which interest accrues on each leg of the transaction differs, because there are several day count conventions in the fixed-income markets as discussed in Chapter 3. 

This discussion covers the main factors affecting bond returns in the European fixed income market, namely, the random fluctuations of interest rates and bond yield spreads, the risk of an obligor defaulting on its debt, or issuer-specific risk, and currency risk. There are also other, more subtle sources of risk. Some bonds such as mortgage-backed and asset-backed securities are exposed to prepayment risk, but such instruments still represent a small fraction of the total outstanding European debt. Bonds with embedded options are exposed to volatility risk. However, it is not apparent that this risk is significant outside derivatives markets. 

In today s asset management industry, organizations operations often extend beyond the European fixed income market. Controlling risk firm wide therefore calls for a detailed understanding of what the levels of risk in each market are and how markets interact with each other. The purpose of this last section is to provide a few elements of comparison between the euro and US dollar fixed income markets. 

Tracking error calculations have a relatively long history in the equity markets of measuring the relative risk of a portfolio against an index. The popularity of this methodology in equities has led many fixed-income managers to adopt the same approach, but we believe it is not as appropriate for the fixed-income markets. 

The belief that markets will change in structure and composition over time is almost axiomatic among market participants. These changes are often more pronounced in fixed-income market than in the equities market, primarily due to the fact that the number of securities in fixed income is much larger, and the churn associated with new issues and bonds maturing is significant. 

Unlike bonds, equities do not mature. Equity portfolios and their benchmarks have the same expected duration (i.e., that of a perpetual security) at the end of a certain period as they did at the beginning. The duration of a fixed-income portfolio comes down over time through a process known as duration drift, which does not occur in equities. Duration drift is an important consideration when looking at a portfolio over a 1-year horizon given that returns are predominantly duration-driven in fixed income markets. 

Investing in Emerging Fixed Income Markets edited by Frank J. Fabozzi and Efstathia Pilarinu... 

Part One describes fixed-income market analysis and the basic concepts relating to bond instruments. The analytic building blocks are generic and thus applicable to any market. The analysis is simplest when applied to plain vanilla default-free bonds as the instruments analyzed become more complex, additional techniques and assumptions are required. 

Up to now, the discussion has centered essentially on plain vanilla securities, bonds with a fixed-coupon and maturity date. However, much of the fixed-income markets revolves around more complex instruments, arranged to meet specific investor requirements. These include ... 

FRNs in general are highly interest rate sensitive. This is because the leverage involved in the coupon calculation endows them with the highest duration of any instrument traded in the fixed-income market. The note in figure 13.1, for example, has a calendar maturity of three years. As shown in FIGURE 13.2, however, its modified duration is much higher. 

This chapter examines a number of issues relevant to participants in the fixed-income markets. The analysis presented is based on government-bond trading and is confined to generic bonds that are default-free, with no consideration given to factors that apply to corporate bonds, asset- and mortgage-backed bonds, convertibles, or other nonvanilla securities, or to issues such as credit risk and prepayment risk. Nevertheless, the principles adduced are pertinent to all relative-value fixed-income analysis. 

Sundaresan, S. 1997. Fixed Income Markets and Their Derivatives. Cincinnati South-Western, chap. 9. 

Asset-backed bonds, for instance, are issued in a number of tranches— related securities from the same issuer—each of which pays a different fixed or floating coupon. Nevertheless, this is still commonly referred to as the fixed-income market. 

A truly excellent resource and recommended reading for anyone with an interest or involvement in the bond and fixed income markets. ... 

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