Fixed Income Securities Lecture Notes Professor Doron Avramov Hebrew University of Jerusalem Chinese University of Hong Kong Syllabus: Course Description This course explores key concepts in understanding fixed income instruments. It especially develops tools for valuing and modeling risk exposures of fixed income securities and their derivatives. To make the material broadly accessible, concepts are, whenever possible, explained through hands-on applications and examples rather than through advanced mathematics. Never-the-less, the course is quantitative and it requires good background in finance and statistical analysis as well as adequate analytical skills. 2 Professor Doron Avramov, Fixed Income Securities Syllabus: Topics We will comprehensively cover topics related to fixed income instruments, including nominal yields, effective yields, yield to maturity, yield to call/put, spot rates, forward rates, present value, future value, mortgage payments, term structure of interest rates, bond price sensitivity to interest rate changes (duration and convexity), hedging, horizon analysis, credit risk, default probability, recovery rates, floaters, inverse floaters, swaps, forward rate agreements, Eurodollars, convertible bonds, callable bonds, interest rate models, risk neutral pricing, and fixed income arbitrage. 3 Professor Doron Avramov, Fixed Income Securities Syllabus: Motivation Fixed income is important and relevant in the financial economic domain. For one, much of the most successful and unsuccessful investment strategies implemented by highly qualified managed funds have involved fixed income instruments. Domestically and internationally, pension and mutual funds, among others, have largely been specializing in bond investing. Moreover, effective risk management is essential in the uncertain business environment in which interest rate and credit quality fluctuate often abruptly. Such uncertainties invoke the use of fixed income derivatives. 4 Professor Doron Avramov, Fixed Income Securities Syllabus: Motivation Fixed income derivatives are standard instruments for managing financial risk. More than 90% of the world's largest 500 companies use fixed income derivatives to manage interest rate and credit risk exposures. Further, financial engineers keep inventing new fixed income derivatives to help firms transfer risk more effectively and selectively. It is therefore critical for anyone involved in corporate finance or financial risk management to have deep-rooted understanding of interest rate risk and fixed income securities. 5 Professor Doron Avramov, Fixed Income Securities Syllabus: Resources Instructor I welcome students to see me whenever possible to discuss any aspect of the course. Teaching Assistant Recommended text: Handbook of Fixed Income Securities by Pietro Veronesi 6 Professor Doron Avramov, Fixed Income Securities Syllabus: Assessment Home Assignments (20%) – Problem sets will be assigned periodically. You have to submit all problem sets on time to be eligible for taking the final exam. Final Exam (70%) - The final exam will be based on the material and examples covered in class, problem sets, and assigned reading. The exam is closed books and closed notes. However, you will be allowed to bring in one piece of paper with handwritten or typed notes (double-sided, A4 size). You are not allowed to use any other notes. I will allow the use of non-programmable calculators during the exam. 7 Professor Doron Avramov, Fixed Income Securities Syllabus: Assessment Class Participation (10%) - It is mandatory to attend all sessions. If you happen to miss a session, make sure to catch up, as you are fully responsible for class lectures, announcements, handouts, and discussions. If you miss more than three sessions without proper documentations - you will be unable to take this course for credit. 8 Professor Doron Avramov, Fixed Income Securities Overview, Risk Profile, and Trading Strategies 9 Professor Doron Avramov, Fixed Income Securities Classifying Securities Basic Types Major Subtypes Money market instruments Interest-bearing Fixed-income securities Equities Ordinary and Preffered Stocks Options, Futures, Swaptions Derivatives Interest rate derivatives 10 Professor Doron Avramov, Fixed Income Securities