Contents Foreword Preface About the Author PART I: Banking Business, Bank Capital and Debt Market Instruments CHAPTER 1: Bank Business and Bank Capital Banking business Capital Financial statements and ratios The money markets Financial transactions Characteristics of the money market Money market conventions CHAPTER 2: Financial Statements and Ratio Analysis Firm financial structure and company accounts Ratio analysis CHAPTER 3: The Money Markets Introduction Securities quoted on a yield basis Securities quoted on a discount basis Extendable note commercial paper Commercial paper dealing sheet Money market screens on Bloomberg BBVA money market rate screens on Bloomberg Foreign exchange markets Deposits and loans Appendices CHAPTER 4: The Bond Instrument Bond-market basics Capital market participants Overview of the main bond markets Bond pricing and yield: The traditional approach Bond yield Accrued interest, clean and dirty bond prices Floating-rate notes Bond instruments and interest-rate risk Option-adjusted spread analysis Appendices PART II: Bank Treasury Asset–Liability Management CHAPTER 5: Asset–Liability Management I Basic concepts Liquidity gap Managing liquidity The liquidity ratio CHAPTER 6: Asset–Liability Management II Introduction Basic concepts Interest-rate risk and source: Banking book The ALM desk Liquidity and interest-rate risk Critique of the traditional approach The cost of funding Generic ALM policy for different banks Securitisation Appendix CHAPTER 7: ALM Trading Principles Trading approach Repo market specials trading An analysis of special repo rates Matched book trading in repo Hedging tools Appendix CHAPTER 8: Asset-Liability Management III: The ALCO ALCO policy ALCO reporting CHAPTER 9: The Yield Curve Importance of the yield curve Part I: The money market yield curve Using the yield curve Yield-to-maturity (YTM) yield curve The coupon yield curve The par yield curve The zero-coupon (or spot) yield curve Using spot rates in bond analysis The forward yield curve The annuity yield curve The Term Structure Spot and forward rates in the market Analysing and interpreting the yield curve Yield curves as a function of the stochastic behaviour of interest rates Further views on the yield curve Interpreting the yield curve Fitting the yield curve Part II: A further look at spot and forward rates Coupon bonds Introduction to bond analysis using spot rates and forward rates in continuous time Appendices CHAPTER 10: The Determinants of the Swap Spread and Understanding the Term Premium The determinants of the swap spread The term premium Impact of macro-level economic and political factors on swap spreads CHAPTER 11: Introduction to Relative Spread Analysis Relative value analysis: bond spreads Swap spread and Treasury spread Asset-swap spread Z-spread Cash-CDS basis PART III: Financial Instruments, Applications and Hedging CHAPTER 12: Repo Instruments Introduction to repo Repo fundamentals The classic repo The sell/buy-back Comparing classic repo and sell/buy-back Basket repo Repo variations Margin Uses and economic functions of repo Legal description of repo The United Kingdom gilt repo market CHAPTER 13: Money Market Derivatives Forward rate agreements Short-term interest-rate futures Implied Eurodollar yield Fixed basis point spread to Eurodollar rates Using Microsoft Excel to check the market forward rate6 Options Pricing inputs Bounds in option pricing Pricing methodology Assumptions The Black-Scholes model and pricing derivative instruments The put-call parity relationship B-S and the valuation of bond options Interest-rate options and the Black model Comment on the B-S model Stochastic volatility Implied volatility Collars, caps and floors Interest-rate risk exposure and option hedging Appendices CHAPTER 14: Interest-rate Swaps and Overnight- index Swaps Basic characteristics of swaps Non-vanilla interest-rate swaps Overnight interest-rate swaps and Eonia/SONIA swaps Basic interest-rate swap hedging applications Swaptions Bloomberg screens Swap rates and the convexity bias Appendices CHAPTER 15: Hedging using Bond Futures Contracts Introduction Bond futures contracts Futures pricing Hedging using futures The primary hedge measure: bond modified duration and PV01 Position after one month Conclusions CHAPTER 16: Credit Risk and Credit Derivatives ALM and credit risk Credit derivatives: An introduction Asset swaps Credit default swaps Loan-only credit default swaps Total return swaps Credit-linked notes Credit options Index credit derivatives Bank ALM applications of credit derivatives Credit derivatives and ABS markets Supply and demand: CDS of ABS Risks in CDS positions Credit default swap pricing27 CHAPTER 17: Value-at-Risk (VaR) and Credit VaR Introducing Value-at-Risk Correlation Simple VaR calculation Matrix calculation of variance–covariance VaR Confidence intervals Historical VaR methodology Simulation methodology VaR for fixed-income instruments Derivative products and VaR Option gamma Stress testing VaR methodology for credit risk Appendix PART IV: Funding and Balance Sheet Management using Securitisation and Structured Credit Vehicles CHAPTER 18: Introduction to Securitisation1 The concept of securitisation Market participants Reasons for undertaking securitisation The process of securitisation Illustrating the process of securitisation: Airways No. 1 Limited Credit rating considerations CHAPTER 19: Structured, Synthetic and Repackaged Funding Vehicles Asset-backed commercial paper Evolution of ABCP programmes Committed liquidity line funding The synthetic ABCP conduit Synthetic ABCP conduit: Example TRS term sheet ABC Fund Limited Golden Claw Funding Limited Total Return Swap Term Sheet The basket total return swap Structured funding vehicles: Repo conduit Synthetic repackaging structures Synthetic funding structures CHAPTER 20: Mortgage-backed Securities and Covered Bonds Mortgage-backed securities Mortgages Mortgage risk Securities Covered bonds Evaluation and analysis of mortgage-backed bonds Commercial mortgage-backed securities CHAPTER 21: Asset-backed Securities Auto-loan-backed securities Credit card-backed securities Securitisation net interest margin (NIM) structures CHAPTER 22: Collateralised Debt Obligations1 Motivation behind CDO issue Market convergence: money and debt capital markets CDO-squared Analysis and evaluation Investor analysis CHAPTER 23: Synthetic Collateralised Debt Obligations The synthetic CDO Assessing the genesis of the synthetic CDO Synthetic CDO deal structures The managed synthetic CDO The single-tranche synthetic CDO Risk and return on CDOs Pricing methodology for synthetic CDO notes17 Case studies