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AF225: Fixed Income Securities, Debt Markets and the Macro Economy

Session: Two

Prerequisites: Basic mathematics and statistics.

Dr Philippe Mueller
Dr Andrea Vedolin

This course helps to develop the relevant knowledge and understanding of fixed income instruments and interest rate models for students aiming for a career in the fixed income field. The course will provide an overview of the major institutions, organisations and investors, and the recent developments in fixed income, covering both theoretical background and practical implementation. 

We will discuss traditional debt instruments (namely government and corporate bonds) and fixed income derivatives (including mortgage-backed securities), develop the theory for valuing them and study the determinants of risk and return of fixed-income securities. To this end we will cover the most important state-of-the-art interest rate models, develop their theoretical underpinnings and provide examples for the practical implementation.  We will also discuss the role of fixed-income securities in risk management and introduce the concepts of duration and convexity. 

Furthermore, we will take a closer look at the interdependencies and the roles of the different players in the debt markets. In particular, we will examine the role of and the instruments available to the central bank in setting interest rates. The major focus of the course will be on economic intuition and on understanding the products and interrelationships in the fixed income markets. We will relate the course topics to the credit crisis of 2007-2009 and discuss implications for the future of debt markets. 

The topics covered in this course include:

  • An overview of debt markets with a focus on the US and the UK: players, institutions and various instruments.
  • Organisation and structure of debt markets. Terminology, market conventions. Specific markets: US Treasury, corporate, agency markets, inter-bank market, etc.
  • Basics of fixed income securities: discount factors, yield curve, term structure of interest rates, coupon and zero coupon bonds.
  • Basics of interest rate risk management: variation in interest rates, duration, convexity, risk measurement and management. Interest rate risk, liquidity risk, inflation risk, credit risk.
  • Term structure models: binomial trees, risk neutral pricing, no-arbitrage and pricing of interest rate securities.
  • Monetary policy and the role of the central bank in setting interest rates. Interest rates and inflation. Relationship between interest rates and future economic activity.
  • Fixed-income derivatives: Treasury futures, Eurodollar futures, options, swaps, mortgage backed securities.
  • Credit derivatives.
  • The 2007-2009 credit crisis.

Main textbook
Pietro Veronesi, Fixed Income Securities: Valuation, Risk, and Risk Management, Wiley and Sons, 2010.

Additional textbooks
Suresh M. Sundaresan, Fixed-Income Markets and Their Derivatives (3rd edition), Academic Press, 2009.
Frank Fabozzi, Bond Markets, Analysis and Strategies (7th edition), Prentice Hall, 2010.

Lectures: 36 hours    Classes: 12 hours
Assessment: Two written examinations