The TA for this class is Sunil Teluja. He resides in the PhD student carrels in Room 315. His e-mail address is sunilteluja@email.arizona.edu . His office hours are W 10:30 - noon and F 11:30 - 1:30.
Required Materials:
- Book:
- Fixed Income Securities, (John Wiley) , by Pietro Veronesi.
- I expect you to subscribe to The Wall Street Journal and read it daily.
- The Economist is also recommended reading.
Institutional and Intellectual Context of the course:
This class serves as an introduction to debt securities as well as the behavior of interest rates.
Management of debt and obtaining capital and working capital at the lowest cost is an important part of corporate finance. CFOs and corporate treasurers work with commercial and investment bankers to structure their liabilities. To such managers a basic knowledge of the Fixed Income environment is critical.
On Wall Street, Fixed Income securites run the gammit from the staid, traditional US Treasury securities to complex Collaterized Debt Obligations. A big part of this course is an introduction to the institutional context of fixed income. As an example, Mortgage Backed Securities provide an early example of financial engineering. Why do such securities exist? What is the role of the US Government (via Ginnie Mae), and Government Sponsored Enterprises, such as Fannie Mae and Freddie Mac?
Traditionally, Fixed Income has been the most quantitative area within finance. The (ironic) reason for this is that the securities tend to simpler than equity securities. The simplicity of the securities' cash flows suggests that there should exist tools to evaluate the value and riskiness of fixed income securities.
Perhaps the most important situation in the financial markets over the past fifty years has been the credit crisis which started in the summer of 2007. The catalyst for this credit event is the fall in house prices in both the United States and the United Kingdom. Placed in a backdrop of extraordinarily liberal credit standards for home buyers means that credit risks are high and potentially lurking in unexpected places. Investment Banks, Commercial Banks, and Hedge Funds with exposure to mortgage credit are especially vulnerable. The surprise unwinding of Bear Stearns in March, 2008 (terminating in the purchase of Bear Stearns by J.P. Morgan-Chase on May 30, 2008), facilitated by federal regulators, is but one example of the consequences. A consequence of this is that matters relating to the world of fixed income have moved from the back office to the headlines.
The most surprising event in Wall Street history was the bankruptcy of Lehman Brothers in September, 2008. This clarified the severity of the on-going financial crisis, but it muddied the waters in terms of governmental involvement and the concept of too big to fail. My slides on the evolution of the 2007--20?? financial crisis.
In mid-2017 the effects of this financial crisis are still reverberating through the world economy. The popularity of populist and isolationist economic policies can be laid at the feet of the fragility in the global economy that the financial crisis highlighted. This has led to fragility of the British Pound, and has brought the stability of European banks into question. In the face of this a flight-to-quality in financial markets keeps yields on US Treasury securities at historically low levels. As we enter the fall of 2017 financial markets are focused on the question of what the US Federal Reserve will do along 2 dimensions. First, the federal funds rate. The Fed wants to return to normal conditions, but confronts an economy with weak wage growth and low inflation. Second, the Fed greatly expanded its balance sheet during the financial crisis. On April 26, 2017 the Federal Reserve owned $2.5 trillion in US Treasury securities and $1.8 trillion in mortgage-backed securities. By comparison, on December 31, 2004, the Fed owned $0.7 trillion in US Treasury securities and no mortgage-backed securities.
Conduct of Course and Grading:
With the exception of the first class, every class will start with a 25 minute quiz (time approximate). The quizzes are designed to verify that you are mastering the basic skills from the last class and/or to ensure that you are staying on task with the reading assignments. Of the 14 quizzes, the lowest may be dropped and your class grade will be the average of the remaining 13. The exception is that the last quiz, Quiz 14 (on December 5), may not be dropped.
Learning Outcomes:
Upon completion of this course students will have mastery of the following material:Institutional Knowledge:
- Know the role of the Federal Reserve in financial markets.
- Know the tools that the Federal Reserve uses to fulfill its role.
- Understand the manner that the US Treasury interacts with financial markets.
- Understand the primary market:
- Treasury sealed-bid auctions,
- The when-issued market for US Treasuries.
- Understand the secondary market: Clean Price, accrued interest.
- Be able to identify future cash flows on all US Treasury securities--both nominal and inflation-indexed.
- Understand the role of the Repo market:
- In financing long positions in Fixed Income securities.
- In securities lending and shorting financial securities.
- Understand Forward Rate Agreements and Plain-Vanilla Interest Rate Swaps.
Analytical Tools:
- Extract spot and forward rates from financial press, e.g., Bloomberg.
- Know how to build a yield curve and interpret its implications for the macroeconomy.
- Develop an understanding of the law of one price (LOOP) and the absence of arbitrage.
- Apply the LOOP / absence of arbitrage in the US Treasury Market.
- Know how to measure interest rate risk using both Duration and DV01 of both individual securities and levered positions.
- Use VBA to simulate interest rates under a 1-factor Vasicek model, and examine a dynamic immunization strategy.
- Understand the role of convexity in the valuation of fixed income securities.
- Build a duration-neutral position to buy or sell convexity, and understand the butterfly spread in the yield curve.
- Use Matlab to obtain principal components from a panel of interest rates
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Evacuation ProceduresMap of the first floor of McClelland Hall for Evacuation Purposes.
Sat Aug 12 10:31:09 MST 2017