School of Bonds & Fixed Income Products

Euromoney Learning Solutions

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Euromoney Learning Solutions

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Who should attend

  • Treasury managers in banks and non-financial institutions non-financial institutions
  • Sales staff employed by banks selling treasury products to corporate clients
  • Support staff, including those involved in back and middle office functions
  • Internal and external auditors
  • Risk managers/analysts
  • Finance directors
  • Finance managers
  • Legal staff
  • Accountants and auditors

About the course

Enhance your knowledge in bonds and fixed income products, book now!

The bond market enables governments, supra-national organisations, agencies (SSA) and corporates to raise capital to invest for future growth. Its importance to the financial infrastructure should not be under-estimated with the market size of the global debt capital markets estimated by ICMA to exceed $128.3tn as of August 2020, with cumulative global bond issuance growing from less than $1tn in Q1 2010 to almost $80tn by Q2 2020, largely on the back of increased borrowing by sovereigns to fund fiscal deficits as a result of the financial crisis and corporates due to the lower interest rate environment and reduced lending capacity of commercial banks. This trend will continue as all G7 counties fight the economic consequences of the pandemic with increased fiscal deficits that require financing.

The bond market is not only a medium for raising capital, I t also informs market participants of the current macro-economic environment and its future development. This five-day programme begins with a general introduction to the bond market and bond market instruments, outlining the various forms that they take. A large focus of the programme is devoted to the sovereign bond market, as not only is it the largest constituent, representing c. 68% of the total global amount outstanding, it also provides (a degree of) price discovery for other, credit sensitive, securities. This focus includes a detailed understanding of price and yield, what factors influence the yield curve, including the role of the Central Bank, and a comprehensive analysis of risk measures used by market participants, distinguishing between such measures as duration, modified duration and dollar duration, plus an analysis of second order effects and their influence on the yield curve. The programme concludes with an analysis of swap instruments and their role in the debt capital market and government bond futures contracts. The content is continually updated to include all the recent developments in the market, including, for example, the impact of new Treasury bond issuance along the curve, and the introduction of new benchmark risk-free rates and their implications for IRS and credit spread measurements.

Summary of course content

  • The bond markets and its participants
  • Bond instrument types, including fixed income securities, floating rate notes and inflation-linked notes
  • Pricing of fixed income securities
  • Standardizing the price: Understanding measures of yield
  • What factors determine the shape of the yield curve?
  • Understanding duration and convexity
  • Swaps and how they interact with bond instruments
  • The role of government bonds futures contracts

Agenda

Day One: Introduction to Bonds: Types of Instrument

Session One: Overview

The bond market is the largest capital market, exceeding the size of the global equity market in the amount outstanding by over 30%, and over the past decade, in a period of fiscal expansion and loose monetary policy driven by the Financial Crisis in 2007/08 and more recently the Covid-19 pandemic, has witnessed enormous growth in issuance and amount outstanding in debt securities issued by sovereigns, supra-nationals and agencies (SSC) and corporate entities alike. This session discusses the market for government bonds, focusing attention on the US Treasury market and UK gilt market, outlining the characteristics of these instruments and how they issued and traded in the secondary market. We then look at typical corporate bond structures and the particular characteristics that differentiate them from sovereign bonds.

  • What is a bond?
  • Bond characteristics
    • Coupon: fixed, floating, zero
    • Price/yield relationship
  • The government bond market
    • The issuance calendar
    • Primary issuance of government bonds: The auction process
      • Single v multiple price
      • Worked example of each
      • Which methods are used in practice?
      • US Treasury auction data
    • On- v off-the-run bonds
    • Government bonds as price discovery mechanism for other instruments
  • Corporate bond issuance and features common to corporate bonds
    • Assessing the credit quality of the issuer and the role of Credit Rating Agencies
    • Syndication
      • Parties involved
      • Process
    • “Make whole” call features and “poison puts”   Session Two: Floating Rate Notes (FRNs)

Floating rate notes (FRNs) form an important segment of the debt capital market. Sovereign issuance in this form is not common, although the US Fed added a two-year UST FRN in January 2014, with the semi-annual interest payments linked to the 13-week Treasury bill. As such, the market for FRNs is largely dominated by corporate issuance, notably by financial institutions. These issues were traditionally linked to term Libor, or equivalent, rates; however, as ‘ibor rates are now phased out and replaced by alternative near risk-free rates based on overnight interbank and secured rates, the structure of these issues will change. This session describes the mechanics of the two-year UST FRN, before concentrating on corporate issuance linked firstly to Libor and then to the new overnight benchmark rates, and in particular how these FRNs will be structured.

  • Who issues FRNs and why
  • Us Treasury two-year FRN
    • Motivation for investors
    • Understanding the note mechanics with the T-Bill rate as the reference rate
  • Typical corporate issues linked to ‘ibor rates
  • Next generation issues referenced to the new near risk-free rates
    • Transition from ‘ibor referenced notes to overnight rate referenced
    • Challenges with referencing to an overnight rate
    • Examples of recent issues

Session Three: Investing for a “Real” Return: Inflation-Linked Bonds

By far and away, securities referenced to nominal rates form the largest segment of the market. However, around 20% of the sovereign bond market in the leading currencies is referenced to a real return. With uncertainty over whether the fiscal and monetary responses to the pandemic will lead to the build-up of (significant0 inflationary pressures, the inclusion of instruments with returns linked to an inflation adjusted return will potentially become more important in future years. This session discusses the rational for holding securities that provide investors with a real, rather than nominal, return, and the how the inclusion of such securities in a debt portfolio can reduce risk without diminishing return. The session concludes with a discussion on the mechanics of US Treasury Protected Securities (TIPS), illustrating how a real return is achieved.

  • Rationale for issuance
  • Market size
  • Mechanics explained:
    • US Treasury Inflation Protected Securities (TIPS)
    • Other market approaches
  • Real v nominal returns
  • What about deflation?
  • What are the (hidden) risks?
  • Other instruments referenced to real returns: Inflation swaps
  • The role of inflation-linked instruments in portfolio construction

Day Two: Bond Analytics (1)

Session One: Fixed Income Valuation

Understanding how the price and yield of a bond inter-relate, and how a bond is quoted, is essential in both the primary and secondary markets. This session describes how the price of a bond is derived and then looks in greater detail at the price/yield relationship. The analysis is extended to include FRNs and index-linked bonds and concludes with a discussion on the forward rate, how it is derived, and its importance in informing central bank monetary policy objectives.

  • Bonds as a series of future cash flows
  • Quoting cash bond prices: Determining the settlement price
    • Concept of quoted (clean) v transaction (dirty) prices
    • Calculating accrued interest
      • How do they differ from dividends?
      • UK gilts and the ex-coupon period
    • How are T-Bills different?
  • Valuation: calculating a bond’s price
  • Common accrual conventions
  • Calculating a bond’s price on a non-coupon date
  • What about inflation-linked bonds?
  • Determining the margin on FRNs
  • Interpreting the price: defining yield measures
    • Yield to maturity as an internal rate of return (IRR)
    • Yield to call
    • Running yield
  • Forward yields: The ten-year rate as a combination of the five-year rate and 5 x 5 forward rate

Session Two: Yield Curves

The yield curve describes the relationship between the yield of a bond and its maturity. It is of huge significance as it not only provides insight as to how the macro-economy is currently performing (and is a leading indicator for the future path of the economy), but also has a direct influence on the macro-economy itself and as such, is subject to deliberate central bank intervention, not least since the financial crisis and the onset of the pandemic. The session explores what factors influence the shape of the yield curve, the impact central bank intervention has on the curve, and whether we can interpret from the shape of the curve what the path future monetary policy will take and how the macro economy will perform.

  • Understanding the term structure of rates: The yield curve
  • The “benchmark” yield curve:
    • The Treasury curve
    • What determines the level and shape of the yield curve?
      • Inflationary expectations and the real return
      • Impact of central bank intervention (QE) on the principal government bond yield curves
        • Macro-economic policy and its impact on short- and long-term yields
    • Lessons from post Covid-19 yield curve changes in UK & US government yield curves: Are they signaling a return of inflation?
    • Alternative benchmark curves

Session Three: The Zero-Coupon Curve

The zero-coupon curve is distinct from the yield-to-maturity curve and is the fundamental building block for the valuation of instruments, whether cash or derivative, such as swaps. The session outlines the limitations of the yield-to-maturity measure and then provides the theoretical basis for using zero rates in the valuation process, before outlining how zero rates can be derived from standard bond instruments. The session then moves on to idendify how zero rates are used in practice, and, in particular, how credit spreads are evaluated.

  • The problem with YTMs:
    • Re‐investment risk
    • Understanding the zero‐coupon bond pricing concept and its importance in the marking‐to‐market process
  • Constructing the zero‐coupon equivalent yield curve
  • The government bond “strips” curve
  • Using zero‐coupon discount factors in the price discovery process
  • Determining the credit spread:
    • Using zero rates to find the Z-spread  

Day Three: Bond Analytics (2)

Session One: Duration, Modified Duration & Dollar Duration Explained

The bond market has developed a number of tools to help in the trading of debt securities and hedging exposures, notably measures that describe the impact of a change in yield on the price of the instrument. This session describes the various measures that are commonly quoted, including duration, modified duration and dollar duration, PV01, DV01 etc. distinguishing between the various measures and illustrating how the Bloomberg numbers shown on the “Yield Analysis” page are calculated and how the measures can be derived in a portfolio context.

  • Understanding the price-yield relationship for option-free bonds
  • Determinants of bond price sensitivity
  • Measures of bond price sensitivity:
    • Macaulay Duration
    • Modified Duration
    • Dollar Duration, PVBP (Present Value of a Basis Point)
  • Calculation and interpretation of duration
  • The non-linear properties of duration: time, yield and coupon dependencies
  • Calculating the duration of a bond portfolio
  • What about FRNs?

Session Two: Second order

Effects: Convexity

This session highlights the limitations of duration analysis and explores the second order effects, “convexity”, how to value it, how to trade it, and what impact it has on long-term yields.

  • Convexity defined
  • Calculating convexity for fixed coupon bonds
  • The implications and ‘value’ of positive & negative convexity on market yields
  • Relationship between convexity and interest rate volatility
  • Limitations of duration and convexity: assumptions, benefits & shortcomings
  • Curve duration, curve convexity and effective duration
  • The “value” of convexity
    • The “butterfly” trade and its impact on long-dated yields

Day Four: Fixed Income Derivative Instruments (1)

Session One: Introduction to the Swaps Market

The interest rate swap market, where a fixed rate is exchanged for a floating reference rate, has undergone significant reform following the Financial Crisis, not least by the recent introduction of the new risk-free benchmark interest rates, all of which has radically changed the nature of the market. This session introduces interest rate swap (“IRS”) instruments, before moving on to discuss the impact of market developments following the financial crisis, notably the impact of collateralisation on the marking-to-market of IRS, and the various issues surrounding the transition from ‘ibor rates to the new risk-free benchmark rates, notably the rise of the overnight index swap (OIS) market and its growing importance.

  • Introduction to the interest rate swap market
    • Understanding the cash flows
    • Current market conventions
  • Market developments since the financial crisis
    • Introduction of collateralisation and central clearing through CCPs and their implications
    • Marking-to-market IRS in the new environment
    • Benchmarking issues:
      • Why we need a benchmark rate
      • The end of ISDA Fix
      • The new regime
  • Market development following the introduction of the new risk-free benchmark rates
    • Transitioning from IRS to OIS
      • Overnight index swap (OIS) mechanics explained
      • The relationship between the OIS and term Libor rates pre- and post- the financial crisis
      • Implications for forward rates and interest rate swap instruments
  • Swap futures contracts

Session Two: Swaps & Fixed income Securities

This session outlines the role that swaps play in liability and asset management of individual bond positions and bond portfolios, whilst also describing how they used in the price discovery process for credit sensitive instruments, and how the recent changes in the benchmark risk-free rates will impact on this.

  • Using IRS in liability management
    • The role of swaps in the primary bond issuance market
    • Motivation for switching from a fixed liability structure to a floating liability structure
  • Using IRS in asset management
    • Understanding the motivation for asset swaps
    • Using cross currency basis swaps to change the currency and interest rate exposure
  • Swaps and price discovery
    • Revisiting the credit spread and the role of the asset swap spread
    • What will be the impact of the switch to OIS?   Day Five: Fixed Income Derivative Instruments (2)

Session One: Bond Futures

Contracts: Contract Design

Futures contracts referenced to sovereign bonds are one of the most heavily traded derivatives contracts in the market, with futures referenced to USTs, one of the largest; e.g. Q1 2021 Treasury futures average daily volume (ADV) increased Q-to-Q by more than 50% to 5.2m contracts (c. $520bn), far exceeding average daily transactions in the cash market. With sovereign bond issuance growing at a rapid rate in all G7 countries, the bond futures market’s importance will only continue to grow. This session outlines the principal contracts traded along with recent developments and contract additions, before explaining in detail the contract specification, including the concept of a deliverable basket, price factor system and concept of a cheapest-to-deliver (CTD) bond.

  • The principal contracts and where they trade
  • What role futures contracts play in the financial markets
  • The role of Exchanges and the Clearing House
    • Understanding the margin payments
  • Introducing the contract specification:
    • The deliverable basket concept
    • The delivery procedure
  • Implications of the contract design:
    • The price/conversion factor
    • The cheapest-to-deliver bond
  • Next generation contracts:
    • UST “Ultra” bond futures contracts

Session Two: Bond Futures Contracts: Pricing & Understanding the “Basis”

Futures contracts, in general, are relatively straightforward. However, the inclusion of a deliverable basket in the contract specification results in the futures contract becoming a complex instrument with a number of embedded options, which impacts directly on the pricing of the futures relative to the cash price. This session explores the relationship between the cash price and futures price, which bond will the CTD, and what factors drive the futures price.

  • What determines the futures price?
  • Linking the cash market and futures prices
    • Defining the (gross) basis
    • Calculating and interpreting the implied repo rate (IRR)
  • Determining the “fair” futures price
    • Calculating the cash-and-carry” arbitrage
    • What is the “net” basis and why do we observe it?
  • Identifying the CTD bond
  • What factors determine the futures price
  • What are the embedded options?

Session Three: Applications of Bond Futures

This section concludes by detailing how bond futures are used in practice by market participants to manage portfolios exposures or to trade. * Principal applications * Hedging interest rate risk * Determining the hedge ratio * Hedge imperfections * Trading applications: * Spread trading * Trading the yield curve * Trading the 10-year Ultra v 10-year T-Note futures

Experts

Paul Kitching

The Course Director was the Strategic Development Manager at the London International Financial Futures Exchange (LIFFE), where he was responsible for the research and definition of new specialist swap and risk transfer contracts. Prior to this, he was Head of Interest Rate Product Development wi...

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School of Bonds & Fixed Income Products at Euromoney Learning Solutions

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