Introduction

Fixed-income securities include bonds that promise a fixed income stream and by exten- sion all securities whose valuation and hedging are related to market interest rates. These fixed income financial claims include pure discount bonds, coupon bonds such as Treasury notes and corporate bonds, floating rate notes, callable bonds, among many others, issued by public or private entities. Quantitative tools are especially important for understand- ing fixed-income securities: Their cash flows are contractually specified which makes it relatively easy to quantify the payoffs, yet the subtleties of interest rate movements and variations in credit risk ensure that quantitative analysis is useful.

This course covers the valuation and application of a wide variety of fixed income securities and their derivatives. In the first half of the course, we focus on yield curve construction, duration and convexity, and formal term structure models. The goal is to introduce you to at least one equilibrium model and one no-arbitrage model, and to analytical tools used in interest rate modeling and risk management. Next, we first focus on interest rate derivatives such as interest rate swaps, bond options and interest rate options, including caps, floors and and the management of callable debt. We then look beyond interest rate risk, and study other risks that can be inherent in fixed income securities such as credit risk, illiquidity risk, and the risks stemming from securitization.
Prerequisite: Financial Management (FIN 623) or its equivalent

Course Outcomes

After successfully completing this course in fixed income asset valuation, the student should have improved competencies in the following areas of:

1. Creative and Critical Thinking
   • Critical look at the capital market and determine if what they are following the “best” practices.
   • Determine alternate methods of enhancing “investors’ wealth” in fixed income markets.
2. Creation of Value
   • Keeping the primary objective (shareholders’ wealth maximization) clear, how can the firm add value to other stakeholders like debtholders, suppliers and customers?
3. Field Specific Knowledge and Experience
   • Look at the traditional methods of how firms determine the way they finance themselves and apply concepts learned from this course to make changes to the status quo.
4. Some Statistical Data Analysis and Computer Skill
   • The ability to take interest rate-related data and process through statistical procedures using MS Excel and take the results and communicate those results in a understandable way using MS Words.
5. Ethical & Professional Judgment
   • Utilize ethical frameworks to analyze organizational decision-making as it re- lates to fixed income markets.

Textbook

• Required: Frank J. Fabozzi, Fixed Income Mathematics, 4E: Analytical & Statis- tical Techniques, Pearson.
• Reference: Pietro Veronesi, Fixed Income Securities, Wiley.
• Reference: Suresh Sundaresan, Fixed Income Markets and Their Derivatives, El- sevier.

Grading Policies

There will be three (3) 15/20 minutes in-class quizzes. Two (2) best quiz scores out of the possible three will count and will account for 10% of your final course grade. I will announce these quizzes only one lecture in advance. There is one in-class midterm exam. The midterm exam is worth 20.00% of the class grade. I will provide more information on the content of these exams close to the actual dates. Also, there is a final exam. Final exam is worth 20% of the class grade. Each homework will consist of about 10 problems. All homework will be graded and I post detailed solution after the due date. Homework assignments account for 10% of the final grade and graded mainly on perceived effort. Attendance, interaction and aptitude will account for 10% of the final grade.

And then there is a final project, worth the remaining 30% of your final grade, due on the on or before the final exam date. In the past I have given a final project consisting of two parts, equally weighted, and my plan is to do the same this Spring. The first part is typically about bond pricing and interest rate risk, the second part is typically about another risk inherent in fixed income securities that we cover in the second part of the class. Students should prepare a write-up in groups (up to four students), have to do a class presentation and the submission should be joint as well. Please limit the write-up to four pages of text; you can add tables or graphs.

In order to be eligible to receive a final grade in this course, you have to take all three exams. Under special circumstance, I will arrange for make-up exams, but each one of you are eligible to take only one make-up. You have to go through proper channel (student services office) and provide me with documents supporting (e.g., medical certificates) your reasons for absence. I will give +/− grades for this course.