Table of Contents
Preface xiii
Acknowledgements xv
Part 1: A Beginner's Toolkit 1
1 Money markets 3
What is money? 3
Why there is a money market? 4
Choosing a maturity 6
Repo 7
Central-bank money-market operations 9
Two money markets 10
The euro 12
Writing money 13
Settlement details 15
Summary 16
2 Government bonds 17
Introduction 17
The concept of yield 18
Example yield calculations 19
Coupon and yield 22
The yield curve 23
Primary dealers 24
Government bond markets 24
Repo as part of the government-bond market 26
Accrued interest 27
Strips 27
Other tradable government debt 29
Non-government debt 31
Rating agencies 32
Summary 33
3 Futures 35
The gold miner's problem 35
The gold miner's solution 36
Contract specification 37
Credit and margin 38
Cash settlement 39
Cash-settling other contracts 40
The fixings 41
The 3-month interest rate future 43
Price action 44
The strip and TED spreads 46
Arbitrage 47
Some trading jargon 48
Summary 50
4 Swaps 51
Introduction 51
An example 53
Asset swaps 55
A typical swap in detail 56
Credit risk in swaps 58
Trading jargon 59
Swaps and interest rate futures 60
Myth and reality 61
Summary 62
5 Options 63
Introduction 63
Puts and calls 63
What is the option worth? 65
Combinations 66
Underlyings 66
Embedded options 67
Implied volatility 68
Summary 69
6 Foreign exchange 71
The basic rationale 71
Size and conventions 72
Forwards 72
Shake the dice 73
Summary 75
7 Players 77
Governments 77
Pseudo-government issuers 78
Non-Financial corporations 79
Pension funds 79
Insurers 81
Mutual funds 82
Hedge funds 83
Commercial banks 83
Mortgage lenders 85
Central banks 86
Private investors 87
Summary 87
8 People 89
Introduction 89
Proprietary traders 89
Market makers 91
Brokers 92
Salespeople 93
Researchers 94
Back office and middle office 94
Investment bankers 94
Summary 95
9 Price action 97
Why do prices move? 97
Necessity never made a good bargain 99
Stability and leverage 100
Fixed-income prices 101
A stylised crash in fixed income 103
Forwards, zeros and par yields 104
Trading the crash 108
Market irrationality 109
Summary 110
Part 2: More detail 111
10 Swaps revisited 113
Introduction 113
Credit risk in swaps 113
Reducing the credit risk 114
Cross-currency basis swaps 116
The price of a basis swap 117
A cross-currency issue 118
Reducing credit risk in basis swaps 121
Forward rate agreements 122
Summary 122
11 Non-government issuance 125
Introduction 125
Bringing a deal to market 126
The syndicate 128
Book-building: taking orders 129
Pricing a swapped deal 130
Pricing an unswapped deal 131
Some legal details 132
Free to trade 134
An example issue 135
Opportunistic reopenings 136
Summary 137
12 Yield, duration, repo and forward bond prices 139
Measuring risk 139
Yields: compounding frequencies 140
Duration continued 142
Definition of DV 01 144
How coupon affects duration and DV 01 144
An example yield curve 145
A 3s10s flattener 147
A flattener generates cash 148
A forward flattener 148
What happens if nothing happens? 149
Weighting the forward flattener 150
A barbell 151
Carry and slide 152
Summary 153
13 Bond futures 155
Introduction 155
Specification 156
Delivery day 157
The delivery process 158
Cheapest to deliver: at par 159
Cheapest to deliver: far from par 160
CTD calculations before delivery 161
Delivery tail 162
Summary 163
14 Basic fixed-income arithmetic 165
The proportion of a year 165
Yield to price and price to yield 167
Semi to annual: halve and square 167
Forward yield 168
Forward asset swap 168
Summary 168
Index 169
