Alberta School of Business Masters of Business Administration Department of Finance and Statistical Analysis
FINANCE 618 X50– Fixed Income
Instructor: Gary Smith, Ph.D., CFA Phone: 780-492-7340
Office: 3-40K Business Building e-mail: [email protected] Office hours: T R 13:30 – 15:00 or by appointment
This course is concerned with fixed income securities, fixed income portfolios, and interest rate risk.
This equivalent to saying the course is concerned with interest rates, interest rate volatility, the yield curve, credit risk, and the tools used for managing exposure to these things. Our exploration of these topics has several goals. First, this course should make the student conversant with working with interest rates in doing calculations and expressing rates in different yet equivalent forms. Second, after this course, the student should be able to extract considerable information from the yield curve and to have an understanding of the term structure of interest rates. Third, this course will give students the tools to analyze the risk characteristics of individual fixed income securities and portfolios of fixed income securities, including those securities with embedded options. These tools will help the student construct portfolios consistent with various market outlooks. The tools will also help one deconstruct an existing portfolio or security in order to determine its inherent risks. Also, this course will provide the student with some knowledge of the instruments that are available in the marketplace.
While we will not shy away from theory where appropriate, I hope to make this course very practical.
That said, a practical study of fixed income is also quite technical: there is quite a lot of math and a lot of computations. The challenge is in taking the numbers, which are found mechanically, and interpreting them into statements about expectations, risks, and value. With these expectations in hand, one can use the instruments we will discuss to build appropriate desired positions.
Required textbooks:
1. Fixed Income Markets and Their Derivatives, Third Edition, by S. Sundaresan, Academic Press, 2009.
2. Fixed Income Readings for FIN 618, McGraw-Hill eBook.
You may download this from http://create.mcgraw-hill.com/shop/. Search for the book by ISBN:
9781121810822 or by school. You will be asked to register and then you will be able to purchase. I have chosen the ebook format, as it is inexpensive. The quoted cost of this is less than US$20.
Other useful book:
Fixed Income Securities: Tools for Today’s Markets, 3rd Edition, by Bruce Tuckman and Angel Serrat, Wiley, 2012.
Fundamentals of Futures and Options Markets, 7th Edition, by John C. Hull, Prentice Hall, 2011. I will refer to this as Hull.
Other materials: Other materials – cases, readings, spreadsheets, and the like – will be made available through uLearn.
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Very tentative order of topic coverage
(subject to change, see important note following this table):
Topic Selected Items Readings
1 Preliminaries • Exploratory quiz (no credit)
• Interest rate quoting
• Risks
Sundaresan Ch. 1 Posted reading EAR and APR 2 Bond basics, calculation
conventions • Security structure
• Calculation conventions
Sundaresan Ch. 2 Posted: “Canadian Conventions”
3 Institutional details, repo
markets • Central banks
• Repurchase agreements
Sundaresan Ch. 3-6 Much of this can be skimmed 4 Bond math and common risk
measures • Duration
• Convexity
• Effective duration and convexity
Sundaresan Ch. 7
5 The yield curve • Yield curve analysis
• Forward rates
• PCA
• Bootstrapping and Splines
• Key rate duration
Sundaresan Ch. 8 Ebook readings 1- 5 Key rate duration article to be
made available separately 6 Yield curve modeling; Valuing
bonds with embedded options;
Option-adjusted Spread
• Yield curve models
• Interest rate “trees”
Sundaresan Ch. 9 Ebook readings 6 and 7
7 Credit Risk • Credit ratings
• Default models
Sundaresan Ch. 10 8 Inflation-linked bonds • Real Return Bonds in Canada
• TIPS in US
Sundaresan Ch. 11 Ebook reading 13 9 Forward rate agreements and
Interest Rate Futures • FRAs
• Eurodollar futures
• Treasury Bond futures
Sundaresan Ch. 15 and 17
10 Swaps and related derivatives • OIS
• Interest rate swaps
• Currency swaps
• Caps and floors
• Swaptions
Sundaresan Ch. 14 and 16 Ebook reading 8 and 9
11 Credit Derivatives (esp. CDS) • Single-name CDS
• Porfolio CDS
• Index CDS
Sundaresan Ch. 18 Ebook reading 10
12 Convertible securities If time permits Ebook readings 11 and 12 Very Important Note:
Please don’t mistake topic numbers for week numbers. Some topics will take less than a week, while others will take more. Further, we will almost surely deviate from the table above. This is the first time I have used this textbook or taught a fixed income course in this format. Consequently, I am uncertain of how long we will take to get through certain topics. This can work to your advantage, as you will have substantial input on how we spend our time. Also, I am very open to your suggestions about how material is being delivered. Please do not be shy about making suggestions. I will not guarantee that I will do as you suggest, but I am very open-minded and genuinely want to make our time together a good experience for all of us. Thus, your input is appreciated.
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Evaluating your performance:
Performance will be evaluated by way of participation, individual assignments, a midterm exam, and a final exam. The table below provides details.
Task Weight in
final grade Date
Participation 20% This is about showing up, pitching in, making an effort in and out of class. It is not about being “right” when questions arise.
Individual assignments 3 @ 10% each Will be made available at end of Jan, Feb, and Mar. Details to follow.
Midterm Exam 20% 13 February 2013 in class Final Exam 30% 17 April 2013
How to get in touch with me:
• Drop in during posted office hours or contact me to make an appointment outside of those hours. I am happy to set up an appointment at a mutually convenient time, so please do not be shy about asking..
• Send me an email at [email protected]. Please write FIN 618 in the subject line as this helps me ensure I’ll see it in a timely way.
Here are a few thoughts about email:
o I ask that you have reasonable expectations regarding email. I will do my best to respond to email by the end of the following business day. This is a goal, not a promise. While I will usually respond more quickly than that, please understand that there will be times when circumstances prevent me from doing so.
o Email is a poor vehicle for explaining financial concepts, particularly if mathematical notation is required. I’ll do what I can, but often I’ll recommend a conversation if the topic is too
cumbersome to deal with via email.
• Phone 780-492-7340. Please leave a message if I don’t answer.
Important administrative information and some further comments
• Check uLearn daily. This syllabus is a very high level overview of the course. Details
regarding pre-reading requirements, PowerPoint slides, and assorted other materials are posted on uLearn. Much of this is to be downloaded and brought to class. Announcements and
materials posted on uLearn are essential elements of this course. Materials on uLearn will be added to as we move through the term.
• Please ensure that your Excel has the following add-ins enabled. Analysis ToolPak, Analysis ToolPak - VBA; Solver.
• The course is quite technical in nature. At times it may seem as if we are getting too “deep into the weeds” on topics. Rest assured that there is a method to my madness. You will almost surely be pitched fixed income structures that are non-standard. In my experience, non-standard
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structures are rarely pitched when it is in the best interests of the issuer (or investor). I want you to come away from this course with an ability to come up with the right questions to ask about structures. Sometimes they will be worth doing, but I want you to be able to ask the questions that will get you decent pricing.
• Mandated information: The University of Alberta requires that all course outlines contain the following notices:
o The University of Alberta Calendar is committed to the highest standards of academic integrity and honesty. Students are expected to be familiar with these standards regarding academic honesty and to uphold the policies of the University in this respect. Students are particularly urged to familiarize themselves with the provisions of the Code of Student Behaviour (online at www.ualberta.ca/secretariat/appeals.htm) and avoid any behavior which could potentially result in suspicions of cheating, plagiarism, misrepresentation of facts and/or participation in an offence. Academic dishonesty is a serious offence and can result in suspension or expulsion from the University.
o Policy about course outlines can be found in Section 23.4(2) of the University Calendar.
