the handbook of fixed income securities

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FRANK J. FABOZZI

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  • THE HANDBOOK OFFIXED INCOME

    SECURITIES

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  • THE HANDBOOK OFFIXED INCOME

    SECURITIESSeventh Edition

    FRANK J. FABOZZI, Ph.D., CFA, CPA

    Editor

    With the assistance ofSTEVEN V. MANN, Ph.D.

    McGraw-HillNew York Chicago San Francisco Lisbon London Madrid

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    DOI: 10.1036/0071440992

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  • vC O N T E N T S

    Preface xxiiiAcknowledgments xxvContributors xxvii

    PART ONE

    BACKGROUND

    Chapter 1

    Overview of the Types and Features of Fixed Income Securities 3Frank J. Fabozzi, Michael G. Ferri, and Steven V. Mann

    Bonds 3Preferred Stock 15Residential Mortgage-Backed Securities 16Commercial Mortgage-Backed Securities 19Asset-Backed Securities 19Summary 20

    Chapter 2

    Risks Associated with Investing in Fixed Income Securities 21Ravi F. Dattatreya and Frank J. Fabozzi

    Market, or Interest-Rate, Risk 22Reinvestment Risk 22Timing, or Call, Risk 23Credit Risk 24Yield-Curve, or Maturity, Risk 25Ination, or Purchasing Power, Risk 26Liquidity Risk 26Exchange-Rate, or Currency, Risk 27Volatility Risk 28

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  • Political or Legal Risk 28Event Risk 29Sector Risk 29Other Risks 29Summary 29

    Chapter 3

    The Primary and Secondary Bond Markets 31Frank J. Fabozzi and Frank J. Jones

    Primary Market 31Secondary Markets 39Summary 51

    Chapter 4

    Bond Market Indexes 53Frank K. Reilly and David J. Wright

    Uses of Bond Indexes 53Building and Maintaining a Bond Index 55Description of Alternative Bond Indexes 56Risk/Return Characteristics 61Correlation Relationships 65Summary 70

    PART TWO

    BASIC ANALYTICS

    Chapter 5

    Bond Pricing, Yield Measures, and Total Return 73Frank J. Fabozzi

    Bond Pricing 73Conventional Yield Measures 86Total Return Analysis 97Summary 105

    Chapter 6

    Calculating Investment Returns 107Bruce J. Feibel

    Single-Period Rate of Return 108Performance of an Investment: Money-Weighted Returns 119

    vi Contents

  • Performance of the Investment Manager: Time-Weighted Returns 125Multiple-Period Return Calculation 129Summary 133

    Chapter 7

    The Structure of Interest Rates 135Frank J. Fabozzi

    The Base Interest Rate 135Risk Premium 135The Term Structure of Interest Rates 139Summary 156

    Chapter 8

    Overview of Forward Rate Analysis 159Antti Ilmanen

    Computation of Par, Spot, and Forward Rates 160Main Inuences on the Yield-Curve Shape 163Using Forward Rate Analysis in Yield-Curve Trades 171

    Chapter 9

    Measuring Interest-Rate Risk 183Frank J. Fabozzi, Gerald W. Buetow, Jr., and Robert R. Johnson

    The Full-Valuation Approach 184Price Volatility Characteristics of Bonds 188Duration 197Modied Duration versus Effective Duration 203Convexity 210Price Value of a Basis Point 222The Importance of Yield Volatility 225

    PART THREE

    SECURITIES

    Chapter 10

    U.S. Treasury and Agency Securities 229Frank J. Fabozzi and Michael J. Fleming

    Treasury Securities 229Agency Securities 242Summary 250

    Contents vii

  • Chapter 11

    Municipal Bonds 251Sylvan G. Feldstein, Frank J. Fabozzi, Alexander M. Grant, Jr., and Patrick M. Kennedy

    Features of Municipal Securities 253Types of Municipal Obligations 255The Commercial Credit Rating of Municipal Bonds 264Municipal Bond Insurance 270Valuation Methods 271Tax Provisions Affecting Municipals 272Yield Relationships within the Municipal Bond Market 276Primary and Secondary Markets 278Bond Indexes 279Ofcial Statement 280Regulation of the Municipal Securities Market 280

    Chapter 12

    Private Money Market Instruments 285Frank J. Fabozzi, Steven V. Mann, and Richard S. Wilson

    Commercial Paper 285Bankers Acceptances 289Large-Denomination Negotiable CDs 292Repurchase Agreements 295Federal Funds 301Summary 303

    Chapter 13

    Corporate Bonds 305Frank J. Fabozzi, Steven V. Mann, and Richard S. Wilson

    The Corporate Trustee 306Some Bond Fundamentals 307Security for Bonds 312Alternative Mechanisms to Retire Debt before Maturity 320Credit Risk 327Event Risk 330High-Yield Bonds 331Default Rates and Recovery Rates 335

    viii Contents

  • Chapter 14

    Medium-Term Notes 339Leland E. Crabbe

    Background of the MTN Market 340Mechanics of the Market 342The Economics of MTNs and Corporate Bonds 344Structured MTNs 347Euro-MTNs 349

    Chapter 15

    Ination-Linked Bonds 351John B. BrynjolfssonMechanics and Measurement 353Marketplace 361Valuation and Performance Dynamics 364Investors 364Issuers 369Other Issues 371Conclusion 372

    Chapter 16

    Floating-Rate Securities 373Frank J. Fabozzi and Steven V. Mann

    General Features of Floaters and Major Product Types 374Call and Put Provisions 376Spread Measures 377Price Volatility Characteristics of Floaters 379Portfolio Strategies 382

    Chapter 17

    Nonconvertible Preferred Stock 385Frank J. Fabozzi and Steven V. Mann

    Preferred Stock Issuance 386Preferred Stock Ratings 390Tax Treatment of Dividends 392

    Contents ix

  • Chapter 18

    International Bond Markets and Instruments 393Christopher B. Steward

    The Instruments: Euro, Foreign, and Global 394U.S.-Pay International Bonds 395Foreign-Pay International Bonds 402Conclusion 408

    Chapter 19

    The Eurobond Market 409David Munves

    Founding and the Early Years 410The Eurobond Market Post-EMU: The Drivers of Development 415The Corporate Eurobond Market Today 426Beyond High-Grade Euro Corporates: The Other Eurobond Sectors 434The Outlook for the Eurobond Market 439

    Chapter 20

    Emerging Markets Debt 441Jane Sachar Brauer

    The Debt Universe 441Emerging Markets Debt Performance History 445Brady Bonds 449Defaults, Exchanges, Restructurings, Workouts, and Litigation 454Derivatives 464Credit-Linked Notes (CLNs) 466Valuation Methods 467Conclusion 469Collateralized Brady Bonds 469Noncollateralized Brady Bonds 470

    Chapter 21

    Stable Value Investments 471John R. Caswell and Karl Tourville

    Stable Value Products 472The Evolution of Stable Value 477Stable Value Portfolio Management 480The Future of Stable Value 485

    x Contents

  • Chapter 22

    An Overview of Mortgages and the Mortgage Market 487Anand K. Bhattachar

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