Short-term fixed-income securities

The Monte Carlo method, however, is prone to model risk. If the stochastic process chosen for the underlying variable is unrealistic, so will be the estimate of VaR. This is why the choice of the underlying model is particularly important. The geometric Brownian motion model described above adequately describes the behavior of some financial variables, but certainly not that of short-term fixed-income securities. In the Brownian motion, shocks on prices are never reversed. This does not represent the price process for default-free bonds, which must converge to their face value at expiration. 

Debt Financing In practice, debt financing covers a variety of fixed-income securities, both long-term and short-term. The most common forms of long-term debt are bonds, mortgages, and debentures. 

This chapter explores interest rate options—a vitat part of the European fixed income securities market. The first section tooks at exchange-traded options, where 20 bittion worth of bond options and over 250 billion of options on short-term rates change hands every day. Next, we ll look at the flexible OTC markets for interest rate options, including caps, collars, swaptions, and structured products. Finally, having explained the products themselves, we ll move on to explore how they can be used to hedge interest rate risk. 

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