Fixed Income Securities

Introduction

This course covers the use and valuation of fixed income securities, like sovereign and corporate bonds, and their derivatives. A fixed income security is a security for which the rule determining future cash flows is set, when the security is issued. The classical example of a fixed income security is a treasury bond, with fixed coupon payments. As long as the government can be trusted to avoid default, there is no cash-flow uncertainty for the bond. In this context, there is only one major source of uncertainty, future interest rates.

The fixed income market is the biggest financial market in the world and includes many different types of debt instruments like pure discount bonds, floating rate notes, callable and puttable bonds, and other. The probability that the issuer will default complicates the analysis with the introduction of credit risk, which creates the division between investment grade and high yield bonds. Further, the liquidity is another risk that holders of such securities need to account for.

Derivatives allow market participants to trade interest rate and credit risk directly with the use of contracts like interest rate and credit default swaps. These enlarge the options available to investors and corporations in relation to their risk-taking and risk-management activities.

A good understanding of fixed income instruments, their derivatives, and markets is very important to financial professionals and very useful to a wider audience of investors and households. In addition, due to the magnitude of the market and the complexity of the instruments there exist many career opportunities in this sector of the financial industry. 

Course content

The following list gives an overview of the key topics to be covered in the course:

• An overview of debt securities markets
• Bond pricing and arbitrage
• Duration and convexity
• Interest rate derivatives
• Central banks, inflation, and monetary policy
• The term structure of interest rates in discrete time
• Fixed income pricing using Binomial models and Monte Carlo simulations
• Credit risk modelling and credit default swaps (CDS)
• Liquididity risk in fixed income markets