 | Bond duration (introduction) Using a simple zero-coupon bond, I illustrate bond duration. We have a few variations, including weighted average time to cash flow, but the best way to view duration is as a SENSITIVITY: the % change in bond price given a % change in yield (YTM). |
 | How to get yield to maturity (YTM) with Excel & TI BA II+ Yield to maturity (YTM, yield) is the bond's internal rate of return (IRR). It is the rate that discounts future cash flows to the current market price. |
 | Bootstrapping the Treasury spot rate curve The theoretical spot rate curve is different than the par yield curve. Here is how to bootstrap the spot rate |
 | Hedging with DV01 An example of using DV01 (dollar value of '01) to calibrate a hedge. Here, I assume we write $1 million in call options; as such, maybe we are worried about an interest rate decline. We can hedge by buying (going long) bonds. The DV01 can calibrate the hedge for us. But it is still crude as (i) duration is just an approximation and (ii) we have much basis risk. |
 | ABCs of CDO (CLO, CBO, CDO of ABS) After illustrating several CDO variations, I illustrate a generic CDO and consider the key differences that give rise to the alphabet soup of collateralized debt obligations (CDOs). The key differences concern the following. Motivation: bank seeks to remove assets from balance sheet (balance sheet) or investors hire collateral manager to seek yield (arbitrage). Risk Transfer: true sale or synthetic via credit default swaps (CDS). Reference Portfolio: many different types but either "physical debt" (loans, bonds) or structured debt (ABS, CDO). Funded: do investors fund (i.e., indirectly sell credit protection to) the entire reference portfolio or only part of the portfolio |
 | Bootstrapping a discount function A discount function is a set of discount factors, where each discount factor is just a present value multiplier. For example, d(1.0) is the present value of $1 dollar received in one year. The key idea is that each d(x) can be solved as one variable under one equation because we already solved for shorter-term discount factors. |
 | Introduction to the yield curve Introduction to the treasury yield curve. |
 | How Money is Created and Destroyed A description of the process by which money is created and destroyed in the United States. |
 | Impact of maturity on bond return The spot rate curve implicitly contains a forward rate curve: An investment in a bond is equivalent to a series of forward loans at rates given by the forward rate curve. To buy a long-term bond is to "purchase" the forward rate curve. Therefore, a short-term bond investor does better/worse depending on the evolution of spot rates vis-a-vis the forward rate curves. If realized spot rates increase relative to the implied forward rates, the short-term investor (who is rolling over) does better. |
 | 58. What Traders Need to Know About The Structure of The Fed http://www.informedtrades.com A lesson on the structure of the Federal reserve for traders and investors in the stock, futures, and forex markets. In our last lesson we finalized our discussion on the importance of interest rates and introduced the Federal Reserve. In today's lesson we're going to continue our discussion on the Federal Reserve by looking at the parts of the Fed which are relevant to us as traders so we can begin to understand how this one institution is able to create drastic moves in the markets. The Federal Reserve has many responsibilities which include regulating banking activity, playing a major role in operating the nation's payments system, and maintaining the stability of the financial system. The role that is most important to us as traders and therefore the role in which we will concentrate on in our lessons, is its role in conducting the nation's monetary policy. ***As a side note here the Federal Reserve is also the Central Bank of the United States. I say this here because most countries have something which operates in much the same way as the Fed which is many times referred to in other countries as the Central Bank. While these institutions may be structured differently from the Fed, from a broad perspective many of the things you learn in our lessons on monetary policy will apply to any central bank. While the Fed's objectives are set by law, its day to day activities are not subject to government approval. This is an important point to understand as it means that unlike Fiscal Policy, which must be approved by both Congress and the President, monetary policy can be enacted as the Fed pleases. This gives the Fed much more control over the economy at least in the short term, and is the reason why some people consider the chairman of the Federal Reserve to be more powerful than even the President. There are many interesting details about The Fed and its structure that I encourage everyone to explore, however the primary components which move markets, and are therefore the ones that we will focus on, are: 1. The Board of Governors: Located in Washington DC the Board of Governors is at the top of The Fed's food chain. It is made up of 7 members who are appointed by the president and confirmed by the Senate. To help keep The Fed from being influenced by political factors, 5 of the Fed Governors are appointed to staggered 14 Year terms. The Chairman and the Vice Chairman are appointed to 4 year terms and can be reappointed should the President wish to have them. 2. The Regional Federal Reserve Banks: This is a network which includes the 12 regional Federal Reserve Banks, and 25 Branches. As most of you already know, different areas of the United States are comprised of different industries. As an example the New York area economy is influenced heavily by what is going on in financial services, while the San Francisco area economy is influenced heavily by what is happening in the technology sector. As this is the case, each of the regional banks are strategically located throughout the country so that the can stay abreast of current economic conditions in each area. |
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