Download Fixed Income Investments Analysis Notes
CIFA ADVANCED LEVEL
FIXED INCOME INVESTMENTS ANALYSIS UNIT DISCRIPTION
This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to value, analyse and determine risk associated with fixed income securities.
Contents
- 1 LEARNING OUTCOMES
- 2 CONTENT
- 3 Overview of fixed income securities
- 4 Markets of fixed income securities: Issuance, trading and funding
- 5 Fundamentals of fixed income valuation
- 6 Fixed income risk and return
- 7 Credit risk management
- 8 The term structure and interest rate dynamics
- 9 The arbitrage-free valuation framework
- 10 Valuation and analysis of bonds with embedded options
- 11 Credit analysis models
- 12 Emerging issues and trends
LEARNING OUTCOMES
A candidate who passes this paper should be able to:
- Identify various types of fixed income instruments
- Assess various types of risks associated with fixed income instruments
- Analyse interest rate volatility using the term structure of interest rate approach
- Value and analyse fixed income instruments
- Value bonds using interest rate models
- Determine the value of bonds using yield and spread analysis
- Apply pricing strategies and evaluate the risk of fixed income securities
- Apply the models to determine credit default rates.
CONTENT
Overview of fixed income securities
- Basic features of fixed income securities
- Types of fixed income securities
- Bond indenture; affirmative and negative covenants; effect of legal, regulatory and tax considerations on the issuance and trading of fixed income securities
- Structure of cash flows of fixed income securities; contingency provisions affecting the timing and/or nature of cash flows of fixed income securities
- Risks associated with fixed income securities
Markets of fixed income securities: Issuance, trading and funding
- Classifications of global fixed income markets
- Interbank offered rates as reference rates in floating-rate debt; mechanisms available for issuing bonds in primary markets; secondary markets for bonds; securities issued by sovereign governments, non-sovereign governments, government agencies and supranational entities; debt securities issued by corporations; short-term funding alternatives available to banks; repurchase agreements (repos)
Fundamentals of fixed income valuation
- Determination of price of the bond given a market discount rate
- Relationships among a bond’s price, coupon rate, maturity and market discount rate (yield-to-maturity)
- Bonds price quotation: spot rates; flat price(clean price), accrued interest and the full price of a bond(dirty price)
- Matrix pricing of a bond
- Yield measures for fixed-rate bonds, floating-rate notes and money market instruments
- Term structure of interest rate: pure expectation theory, liquidity preference theory, market segmentation theory; implications of the yield curve for the yield-curve theories
- Spot curves, yield curve on coupon bonds, par curve and forward curve
- Forward rates; determination of spot rates from forward rates, forward rates from spot rates and the price of a bond using forward rates; yield spread measures
- Bond refinancing/refunding
Download FIXED INCOME INVESTMENTS ANALYSIS CIFA NOTES
Fixed income risk and return
- Return from investing in a fixed-rate bond
- Bond duration measures: Macaulay duration, modified duration and effective durations, portfolio duration; money duration of a bond and price value of a basis point (PVBP)
- Effective duration as a measure of interest rate risk for bonds with embedded options
- Key rate duration as a measure of sensitivity of bonds to changes in the shape of the benchmark yield curve
- Effect of a bond’s maturity, coupon, embedded options and yield level to its interest rate risk
- Bond convexity: approximate convexity; effective convexity; determination of percentage price change of a bond for a specified change in yield, given the bond’s approximate duration and convexity
- Effect of term structure of yield volatility on the interest rate risk of a bond; relationships among a bond’s holding period return, its duration and the investment horizon
- Effect of changes in credit spread and liquidity on yield-to-maturity of a bond and how duration and convexity can be used to estimate the price effect of the changes
Credit risk management
- Credit risk and credit-related risks affecting corporate bonds; seniority rankings of corporate bonds; potential violation of the priority of claims in a bankruptcy proceeding; corporate issuer credit ratings; issue credit ratings; rating agency practice of “notching”; risks in relying on ratings from credit rating agencies; components of traditional credit analysis
- Financial ratios used in credit analysis; credit quality of a corporate bond issuer given key financial ratios of the issuer and the industry
- Factors influencing the level and volatility of yield spreads; determination of return impact of spread changes; special considerations when evaluating the credit of high yield, sovereign and municipal debt issuers and issues
The term structure and interest rate dynamics
- Relationships among spot rates, forward rates, yield to maturity, expected and realised returns on bonds and the shape of the yield curve
- Forward pricing and forward rate models: determination of forward and spot prices and rates using those models
- Assumptions concerning the evolution of spot rates in relation to forward rates implicit in active bond portfolio management; the strategy of riding the yield curve
- Swap rate curve: its use in valuation by market participants; determination and interpretation of the swap spread for a default-free bond; the Z-spread; treasury and Euro dollar(TED) spread and London interbank offer rate(LIBOR) – OIS spreads
- Review of traditional theories of the term structure of interest rates; the implications of each theory to forward rates and the shape of the yield curve
- Modern term structure models and their use; measuring the bond’s exposure to each of the factors driving the yield curve and how these exposures can be used to manage yield curve risks; maturity structure of yield volatilities and their effect on price volatility
The arbitrage-free valuation framework
- Overview of arbitrage-free valuation of a fixed-income instrument
- Computation of the arbitrage-free value of an option-free, fixed-rate coupon bond
- Binomial interest rate tree framework: the backward induction valuation methodology and computation of the value of a fixed-income instrument given its cash flow at each node; process of calibrating a binomial interest rate tree to match a specific term structure
- Pricing using the zero-coupon yield curve and pricing using an arbitrage-free binomial lattice; path wise valuation in a binomial interest rate framework and computation of the value of a fixed-income instrument given its cash flows along each path
- Monte Carlo forward-rate simulation and its application
Valuation and analysis of bonds with embedded options
- Overview of fixed-income securities with embedded options
- Relationships between the values of a callable or putable bond, the underlying option-free (straight) bond and the embedded option; Use of the arbitrage-free framework to value a bond with embedded options
- Effect of interest rate volatility on the value of a callable or putable bond
- Effect of changes in the level and shape of the yield curve on the value of a callable bond
- Determination of the value of a callable or putable bond from an interest rate tree; option-adjusted spreads (OAS); effect of interest rate volatility on option-adjusted spreads
- Effective duration of callable, putable and straight bonds; use of one-sided durations and key rate durations to evaluate the interest rate sensitivity of bonds with embedded options
- Effective convexities of callable, putable and straight bonds
- Determination of the value of a capped or floored floating-rate bond
- Defining features of a convertible bond; components of a convertible bond’s value; valuation of convertible bond in an arbitrage-free framework; risk–return characteristics of a convertible bond, straight bond and underlying common stock.
Credit analysis models
- Overview of credit analysis models; probability of default, loss given default, expected loss and present value of the expected loss and relative importance of each across the credit spectrum
- Credit scoring and credit ratings; ordinal rankings
- Strengths and weaknesses of credit ratings
- Structural models of corporate credit risk: reasons for equity being viewed as a call option on the company’s assets; reduced form models of corporate credit risk
- Reasons for debt being valued as the sum of expected discounted cash flows after adjusting for risk
- Assumptions, strengths and weaknesses of both structural and reduced form models of corporate credit risk
- Determinants of the term structure of credit spreads; present value of the expected loss on a bond over a given time horizon
- Credit analysis required for asset-backed securities
- Credit analysis of corporate debt