All securities can be evaluated in terms of the characteristics common to all as- sets: value, return, risk, maturity, marketability, liquidity, and taxability. In Part 1, debt securities are analyzed in terms of these characteristics. Chapter 1 presents an overview of the investment environment, examining the nature of financial assets, the types of securities that exist, the nature and types of markets that securities give rise to, and the general characteristics of assets. With this background, the next four chapters examine bonds in terms of their characteristics: Chapter 2 looks at how debt instruments are valued and how their rates of return are measured; Chapters 3 and 4 examine the level and term structure of interest rates and show how such factors as market expectations, economic conditions, and risk-return preferences are important in determining the level and structure of rates; Chapter 5 describes three types of bond risk—default, call, and market risk—and introduces two measures of bond volatility: duration and convexity. Part 2 delineates the different debt securities and their markets in terms of the rules, participants, and forces that govern them. Chapter 6 describes the debt claims of businesses; Chapters 7 and 8 look at the types and markets for government securities—Treasury, federal agencies, and municipals; Chapters 9 and 10 examine intermediary and foreign debt securities. In Chapters 11 and 12, mortgage-backed and asset-backed securities are examined. Chapter 11 looks at mortgage-backed securities and explains prepayment risk and how mortgage-backed derivatives are constructed to address the problems of prepayment risk. Chapter 12 looks at the market for other asset-backed securities: commercial mortgage-backed securities, receivable-backed securities, and collateralized debt obligations. Part 3 examines bond strategies and the valuation of bonds with embedded options. In Chapter 13, bond analysis is extended from evaluation to investment and management by examining a number of active and passive bond management strategies, including cash matching, bond immunization, indexing, and contingent immunization. With many bonds having some option clause, the binomial interest rate approach to valuing bonds has become an important pricing model for bonds. Chapter 14 describes how the binomial interest rate tree is used to price bonds with call and put options, sinking fund agreements, convertible clauses, and prepayment options. Chapter 15, in turn, addresses the technical problem of how to construct the tree, examining two models that have been used to estimate the binomial interest rate trees—the arbitrage-free calibration model and the equilibrium model. Part 4 consists of four chapters covering bond derivatives. Chapters 16 and 17 provide overviews of the markets, uses, and pricing of interest rate futures and options contracts. These chapters provide a foundation for the more detailed analysis of hedging and debt management strategies using futures and options contracts that are examined in Chapters 18 and 19. In those chapters, futures and options contracts on debt securities are examined in terms of how they are used by banks and financial intermediaries to manage the maturity gaps between loans and deposits, by corporations and financial institutions to fix the rates on floating-rate loans, and by fixed-income portfolio managers, money managers, investment bankers, and security dealers in locking inthefuture purchase or sellingprice on their fixed-income securities. Part 5 completes the analysis of derivatives with three chapters devoted to swaps: interest rate swaps, swap derivatives, and currency and credit default swaps. The book is a revised second edition that draws from the first edition and two other texts of the author: Options and Futures (West Publishing, 1995) and Intro- duction to Derivatives (Oxford University Press, 2009). The text stresses concepts, model construction, and numerical examples. This is done to empower the reader to understand the tools with which answers can be found rather than just the answers. A number of review questions, problems, and Web exercises are provided at the end of each chapter to reinforce concepts; solutions for many of the problems are provided at the end of the text. A number of the problems can be done using Excel. Readers, in turn, can access Excel programs for working many of those problems, as well as find chapter PowerPoint files and additional resources by going to the book’s complementary Web site.
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