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Interest Rate Markets


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Table of Contents

Acknowledgments xiii Introduction xv CHAPTER 1 Tools of the Trade 1 Basic Statistics 2 Regression: The Fundamentals 6 Regression: How Good a Fit? 11 Principal Components Analysis 14 Scaling through Time 15 Backtesting Strategies 16 Summary 17 CHAPTER 2 Bonds 19 Basics of Bonds 19 Risks Embedded in Fixed Income Instruments 22 Discounting 27 Bond Pricing 28 Yield Curve 32 Duration 34 Convexity 37 Repo Markets 42 Bid Offer 44 Calculating Profit/Loss of a Bond 45 Carry 45 Forward Rates 47 Rolldown/Slide 51 Curves and Spreads 53 Butterfly Trades 55 Summary 56 CHAPTER 3 Fixed Income Markets 59 Federal Reserve 60 Treasuries 67 Strips 70 Tips 71 Mortgages 73 Agency Debt 77 Corporate Bonds 79 Municipal Bonds 82 Summary 84 CHAPTER 4 Interest Rate Futures 85 Basics of Futures Transactions 86 Eurodollar Futures 89 Convexity (or Financing) Bias 92 Creating Longer-Dated Assets Using Eurodollar Futures 93 Treasury Futures 94 Fed Funds Futures 101 Futures Positioning Data 104 Summary 105 CHAPTER 5 Interest Rate Swaps 107 Basic Principles 108 Duration and Convexity 111 Uses of Swaps 112 Counterparty Risk 115 Other Types of Swaps 115 Summary 124 CHAPTER 6 Understanding Drivers of Interest Rates 125 Supply and Demand for Borrowing 126 Components of Fixed Income Supply and Demand 141 Treasury Supply 141 Other Sources of Fixed Income Supply 145 Fixed Income Demand 148 Short-Term Yield Drivers 157 Summary 172 CHAPTER 7 Carry and Relative Value Trades 173 Carry Trades 173 Carry Trade Setup and Evaluation 175 Pitfalls of the Carry Trade 178 Carry-Efficient Directional Trades 182 Relative Value Trades 183 Setting Up Relative Value Trades 185 Treasury Bond Relative Value-Par Curve 191 Other Treasury Relative Value Trades 193 Summary 194 CHAPTER 8 Hedging Risks in Interest Rate Products 197 Principles of Hedging 198 Choices of Instruments for Hedging 202 Calculating Hedge Ratios 210 Yield Betas 215 Convexity Hedging 218 Summary 223 CHAPTER 9 Trading Swap Spreads 225 How Swap Spreads Work 225 Why Trade Swap Spreads? 230 Directionality of Swap Spreads to Yields 240 Futures Asset Swaps 241 Spread Curve Trades 243 Summary 245 CHAPTER 10 Interest Rate Options and Trading Volatility 247 Option Pricing and Fundamentals 249 Modifications for the Interest Rate Markets 254 Quoting Volatility 256 Measuring Risks in Option Positions 257 Put/Call Parity 266 Implied and Realized Volatility 268 Skew 270 Delta Hedging 270 Interest Rate Options 275 Embedded Options and Hedging 280 More Exotic Structures 283 Yield Curve Spread Options 284 Forward Volatility 285 Volatility Trading 286 Interest Rate Skew 293 Volatility Spread Trades 294 Caps versus Swaptions 297 Summary 298 CHAPTER 11 Treasury Futures Basis and Rolls 299 The Futures Delivery Option 299 Calculating the Delivery Option Value 309 Option-Adjusted and Empirical Duration 311 Treasury Futures Rolls 313 Summary 318 CHAPTER 12 Conditional Trades 319 Conditional Curve Trades 320 Conditional Spread Trades 324 Summary 328 References 329 About the Author 331 About the Web Site 333 Index 335

About the Author

Siddhartha Jha is a Senior Analyst with Arrowhawk Capital Partners. Previously, as part of J. P. Morgan's Fixed Income Strategy Team, he covered a wide range of rates markets--from municipals to liquid products including Treasuries, swaps, futures, and options--analyzing macroeconomic trends as well as short-term technical factors. He spent five years there developing trade ideas, building quantitative models, and discussing market trends with institutional investors. He graduated cum laude with a dual bachelor's and master's in applied mathematics and statistics from Harvard University.

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