Pricing and Hedging Interest Rate and Credit Risk Sensitive Instruments
The training "Pricing and Hedging Interest Rate and Credit Risk Sensitive Instruments" covers the following topics:
- Discounted Cash Flow (DCF) Analysis
- One-Factor Interest Rate Risk Metrics
- Multi-Factor Interest Rate Risk Metrics
- Hedging Interest Rate Risk
- Risk Neutral Pricing and Binomial Models
- Implementing the Black-Derman-Toy Model
- Duration, Convexity and OAS with Binomial Pricing
- Pricing Interest Rate Derivatives
- Pricing Defaultable Bonds
- Credit Risk Metrics
- Pricing Credit Derivatives
- Hedging Credit Risk
- Asset-Backed Securities
The training aims to meet the practical needs of risk managers and portfolio managers. The approach is intuitive and mathematically simple (e.g. no continuous time stochastic differential equations); it emphasizes models implementation with applications to representative sample financial instruments, with both Excel spreadsheets and R code examples. The training's philosophy can be summarized as "keep it simple and practical".
1. Discounted Cash Flow (DCF) Analysis
1.1 DCF Analysis
Fixed, floating and inflation-linked bonds DCF pricing; interest rate swaps DCF pricing; par, spot and forward rates; yield to maturity and par yield; discount margin; z-spread.
Part 1 Appendices
1.A Perpetual Bonds Pricing
1.B Principal Protected Notes Pricing
2. One-Factor Interest Rate Risk Metrics
2.1 One-Factor Interest Rate Risk Metrics
Curve/yield duration and convexity measures; interest rate PV01; credit spread PV01 (CS01); portfolio duration and convexity; approximate bond price/portfolio value changes; classical immunization; yield volatility.
Part 2 Appendices
2.A Bond Classifications
2.B Useful Bloomberg Functions
2.C Bond Market Indices
3. Multi-Factor Interest Rate Risk Metrics
3.1 Multi-Factor Interest Rate Risk Metrics
Key Rate Analysis, Key Rate Duration and Key Rate PV01 (KR01); PCA Analysis and Principal Component Durations.
Part 3 Appendices
3.A Cubic Spline Interpolation
3.B The ECB Term Structure Model
3.C Foundations of Return Attribution
4. Hedging Interest Rate Risk
4.1 Hedging Interest Rate Risk
Hedging strategies and basis risk; practical hedging with derivatives; hedging effectiveness.
Part 4 Appendices
4.A Case Study: Metallgesellschaft AG Hedging Program
4.B Currency Hedging
4.C Linear Algebra Review
5. Bond Pricing with Binomial Models
5.1 Risk Neutral Pricing and Binomial Models
State prices and risk neutral probabilities; approaches to build a binomial tree; model calibration.
5.2 Implementing the Black-Derman-Toy Model
Black-Derman-Toy short rate tree and bond price tree; Black-Derman-Toy calibration.
5.3 Duration, Convexity and OAS with Binomial Pricing
Computing effective duration, effective convexity and OAS with binomial models.
6. Pricing Interest Rate Derivatives and Defaultable Bonds
6.1 Pricing Interest Rate Derivatives
Risk-neutral pricing framework; pricing interest rate derivatives with binomial models.
6.2 Pricing Defaultable Bonds
Binomial and DCF defaultable bonds pricing.
Part 6 Appendices
6.A Binomial Pricing vs Monte Carlo Pricing
6.B Black’s Option Pricing Formulas
7. Credit Related Instruments and Credit Risk Metrics
7.1 Credit Default Swaps
Single-name CDS; multi-name CDS; CDS market developments, conventions and activity.
7.2 Other Credit Related Instruments
Asset swaps; credit-linked notes; total return swaps.
7.3 Credit Risk Metrics
Credit ratings; credit spreads; default probability; recovery rates; default correlation.
Part 7 Appendices
7.A CDS case studies
7bis. Pricing and Hedging Credit Risk
7bis.1 Pricing Credit Derivatives
Risk neutral hazard rates; CDS implied survival probabilities; single-name CDS pricing; index CDS pricing; forward-starting CDS pricing; Black’s default swaptions pricing formula.
7bis.2 Hedging Credit Risk
CDS sensitivities; hedging with single-name CDS; hedging with index CDS.
7bis.3 Real World Default Probabilities
Merton model; estimating default probabilities with logistic regression.
8. Asset-Backed Securities
8.1 Asset-Backed Securities
Types of asset-backed securities; securitisation and tranching; single mortgages; prepayment risk; pass-through MBS; sequential-pay CMO; traditional and synthetic CDOs; CLOs now vs CDOs in 2008.
Part 8 Appendices
8.A The Financial Crisis of 2007-2008
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