Fixed Income Analytics: Pricing And Risk Management

By Book Wave Publications

The fixed income markets are central to the modern economy, and are arguably the most central and influential markets in the entire financial system.  Indeed, interest rates, the most important prices in the entire economy, are set in the bond and money markets. A famous and colorful lament from then President-Elect Bill Clinton in 1993 led his aide, James Carville, to declare that in his next life he wanted to come back as something really influential: the bond market.

This Book, which assumes no knowledge of finance, and with minimal math requirements (business school calculus is more than enough) will be useful for financial professionals who wish to go to the next level with their understanding of the fixed income markets, and for quantitative professionals from other fields who are interested in learning something about finance.  If you're looking for one segment of the capital markets to start an exploration of finance, you can't go wrong with the fixed income markets.

This Book teaches quantitative and rigorous techniques for pricing fixed income securities and for analyzing and managing the risks they are exposed to.  We will develop techniques for the analysis of treasury bonds, treasury bills, strips, and repurchase agreements, as well as for bond portfolios.

More than any other asset class, fixed income securities are exposed to risks associated with interest rates.  Moreover, the linkage between fixed income assets and interest rates is very tight.  Thus, by necessity, we will also develop methods for the analysis of interest rates.  We will explore the close linkage between fixed income instruments and interest rates, and we will review the main theories of interest rate term structure.

The pricing of fixed income securities is one of the core objectives of the Book.  We will go well beyond pricing in the analysis of the risks fixed income securities are exposed to. We will treat the classic measures of interest rate risk: dollar duration, DV01, duration, and convexity, and we will see how to use them for real risk management applications.

In the end, everything in this Book is driven by applications, and there are applications galore.  We will cover trading applications, like riding the yield curve and rate level trading.  And we will study risk management techniques like immunization, and applications in asset/liability management.

• Language: English
• Publisher: Book Wave Publications
• Release date: Feb 4, 2024
• ISBN: 9798224424412

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Copyright

Fixed Income Analytics: Pricing And Risk Management

Copyright 2024 by Book Wave Publications

All rights reserved.

All rights reserved. No part of this book may be used or reproduced in any manner whatsoever without written permission except in the case of brief quotations embodied in critical articles and reviews.

Book design by Book Wave Publications, adapted for ebook

Cover design: Book Wave Publications.

Table Of Contents

Copyright

Table Of Contents

About

Property Plant & Equipment

Lump Sum Purchase

Property Plant & Equipment Lump Sum Purchase

Lump Sum Purchase

Straight Line Method of Depreciation

Calculating Depreciation Straight Line

Depreciation Straight Line Ex Part 1

Depreciation Straight Line Ex Part 2

Multiple Choice 1 - Property Plant & Equipment

Double Declining Balance Method of Depreciation

Calculating Depreciation Double Declining Balance

Depreciation Ex Double Declining Part 1

Depreciation Ex Double Declining Part 2

Depreciation Ex Double Declining Part 3

Multiple Choice 2 - Property Plant & Equipment

Units of Production Depreciation Method

Calculating Depreciation Units of Production

Depreciation Units Of Production Part 1

Depreciation Ex Units Of Production Part 2

Multiple Choice 3 - Property Plant & Equipment

Project Management Fundamentals: Run Projects Effectively

What Is A Project ?

Why Is Project Management Important ?

The 5 Stages Of The Project Life Cycle

The Initiation Phase

Business Case

The Project’s Scope

Feasibility Study

Project

Why Is The Planification Phase Important ?

Clarification Of The Scope

Tasks Planification

Gantt Diagram

Project Budget Estimation

Risk Analysis

Kick-Off Meeting

The Project Manager Role During The Execution Phase

Monitor The Project Progress

Track The Budget

Risk Management

Change Management

Presenting The Progress To The Steering Committee

Project Closing

Traditional Methodologies

Agile Project Management Method

Agile Methodologies

Scrum

Kanban

ScrumBan

Lean 6 Sigma

Prince2

PMBOK and PMI

Critical Path and PERT Chart

How To Choose The Best Project Management Methodology

Common Mistakes To Avoid As A Project Manager

A Final Word

About

The fixed income markets are central to the modern economy, and are arguably the most central and influential markets in the entire financial system.  Indeed, interest rates, the most important prices in the entire economy, are set in the bond and money markets. A famous and colorful lament from then President-Elect Bill Clinton in 1993 led his aide, James Carville, to declare that in his next life he wanted to come back as something really influential: the bond market.

This Book, which assumes no knowledge of finance, and with minimal math requirements (business school calculus is more than enough) will be useful for financial professionals who wish to go to the next level with their understanding of the fixed income markets, and for quantitative professionals from other fields who are interested in learning something about finance.  If you're looking for one segment of the capital markets to start an exploration of finance, you can't go wrong with the fixed income markets.

This Book teaches quantitative and rigorous techniques for pricing fixed income securities and for analyzing and managing the risks they are exposed to.  We will develop techniques for the analysis of treasury bonds, treasury bills, strips, and repurchase agreements, as well as for bond portfolios.

More than any other asset class, fixed income securities are exposed to risks associated with interest rates.  Moreover, the linkage between fixed income assets and interest rates is very tight.  Thus, by necessity, we will also develop methods for the analysis of interest rates.  We will explore the close linkage between fixed income instruments and interest rates, and we will review the main theories of interest rate term structure.

The pricing of fixed income securities is one of the core objectives of the Book.  We will go well beyond pricing in the analysis of the risks fixed income securities are exposed to. We will treat the classic measures of interest rate risk: dollar duration, DV01, duration, and convexity, and we will see how to use them for real risk management applications.

In the end, everything in this Book is driven by applications, and there are applications galore.  We will cover trading applications, like riding the yield curve and rate level trading.  And we will study risk management techniques like immunization, and applications in asset/liability management.

Property Plant & Equipment

In this chapter we will discuss property, plants and equipment. Note that property plant and equipment may be called plant assets or appreciable assets and property plant and equipment will include things that are tangible tangible meaning we can actually touch them there are things that are physically tangible we can move them around. Typically they're going to be used in the operations. So when we think about the intangible property the same type of property could be either inventory or property plant and equipment depending on the use of that property. In other words if we had something like a forklift and we used it for the business that would be a form of property plant and equipment.

However if we're in the business of buying and selling forklifts then it would be inventory. So we're talking about those types of tangible assets that are going to be used in the business for business operations and they have a future benefit. So note that all assets basically have a future benefit. That's why we hold them. That's why they are Assif, that's why they're not expensive. We have not yet consumed them in order to help generate revenue in this time period. We're holding them with the hope that they will help us generate revenue in the future. When considering property, plant and equipment we often have that question as to whether we should put something on the books when we purchase it as an asset or should we put it on the books as an expense.

Most of us intuitively know that certain things should be assets such as buildings and equipment and we'll take a look at those examples. However we don't often know exactly why. We intuitively know this. And the rule is because of this future benefit, if we're purchasing something and it has a future benefit then oftentimes it should be put on the books as an asset if we buy a car. We're not the consumers in the car today for today's use. We might be using it a bit today but it's come he used a long time in the future and therefore should be capitalized on the books and then expensed over a time period. So these are going to be the components of the assets that we're talking about in terms of property, plant and equipment.

The lifecycle of property plants and equipment typically will start with the acquisition with the purchase. So for example if we're purchasing a building we're going to have the acquisition first then we're going to allocate cost to the period benefited and that's going to be the key points here and that's why we capitalize it because we cannot allocate the costs at the point in time that it is purchased even if we pay cash for it because we're going to be consuming this property plant and equipment through future time periods and therefore under the matching principle must allocate the cost to those future time periods when it's consumed in order to help generate revenue.

So of course our problem is going to be how to do that. Yes, different ways that we'll talk about how to best make that allocation and we'll need estimates in order to do that. At the end of the assets of the property plant and equipment life we will typically dispose of it at some time. Most probably plants and equipment will not last forever and will have some point in time where we will need to dispose of it. And that's going to be the major three kinds of journal entries that will need to be made when we buy a property plant and equipment which is pretty straightforward. We're just basically going to debit property plants and equipment and assets and credit whatever we pay for cash or a loan.

The tricky part will of course be the allocation and we'll talk about different allocation methods and how to calculate allocation methods and then we'll have the disposal which can be a little bit tricky as well because we will be introducing a new account and that's going to be a contra asset account accumulated depreciation. We've probably seen it before but we haven't really calculated it and worked out how that number comes about. The acquisition cost is going to be part of the property plant and equipment and that's pretty clear when we purchased the property plant and equipment. We know that the purchase price of it will be part of the cost but it's also important to note that expenditures to prepare for use will also be needed.

So if we're putting something in place if we have to we bought a fridge rater and we had to put the fridge Rayder in place and pay for that installation then that installation although it wasn't the sticker price is part of what we need to get it up and running in operations and therefore would be part of that property plant and equipment that we would capitalize not expense and then allocate over the useful lives. So if we talked there's a few different categories now. Property plants and equipment one is going to be machinery. So we're talking machinery and equipment and that of course when we buy something like a forklift it's going to acquire we're going to have the acquisition costs we're going to have those furniture's used expenditures to prepare for use of that forklift.

So whatever we need to do to get the forklift up and running in addition to the acquisition costs we're going to include obviously the price is going to be included in terms of what is capitalized. What we're adding up here is what is going to be capitalized as this forklift. And you would think it would just be the sticker price. But all these things would be included in the acquisition costs, the expenditures that the price would be related to, and the taxes if we had to have sales tax on the forklift that would be included in the installation.

Obviously a forklift you know if we had it here probably insulation wouldn't be here but transport would possibly be here if we had to buy the forklift and then ship it then we wouldn't be able to just expense the shipping costs and note that's really the difference here that we want to keep in mind. The question would be, well , what about the sales tax. Can we expense that or should we capitalize it? No, we need to capitalize it because it was purchased in the forklift. What about the installation if we had to install anything to get the forklift up and running. Can we expense that or should it be capitalized.

Well if it's for the initial purchase and we need to make the installation we should typically capitalize it as part of keeping the forklift up and running getting it ready for use transportation. Should we expense that if we had to pay for the transportation in addition to the sticker price of the forklift or capitalize it along with the forklift. We should capitalize it typically because we've needed the transportation in order to get the forklift up and running. And for us in the operations transport insurance is another example that pays for insurance during the transport process that should be capitalized rather than expensed as well. Another category of property plant and equipment is building. So if we purchased a building we have similar types of things.

The question is Well , what are we going to include in the cost of the building? Similar reasoning would be in place but we have a few different factors when considering the building. Obviously the purchase cost or construction would be in the building. So if we just bought the building then whatever the price would clearly be in it if we construct the building then it can be a little bit confusing to think about because the construction process could be a long process and we're basically capitalizing everything through that entire process of constructing the building as part of the cost of the building meaning we're not typically expenses it's been seen anything during that construction process.

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We're going to put it on the books as it kept last; the title costs tax broker fees for the purchase of the building. Attorney Fees for the purchase of the building. These are all going to be things that will be capitalized along with the building because they need to be done in order to get the building up and running. And again the question would be, can we expense these things or do we should capitalize him and it really depends on your angle as to whether what you would want to do as a business and what the business owner would like to do.

I noticed that capitalizing typically makes the business look better because we're putting it on the books and we're not expanding it over time as quickly. We're not just writing it off at this time period. And therefore net income will typically be higher as well as assets. However for taxes we would typically want net income to be lower in order to write off more deductions and have lower net income and lower taxes. So depending on what your objective is the business may be asking either way and hoping either way that some of these things can be either expensed or capitalized as part of the building.

So for example they might be hoping they can expense some of that of the taxes related to the building so that the lower their taxes their income taxes and the brokerage fee the question could be what can I write off the brokerage fee this year rather than capitalizing it and then expensing it and those types of things can add up. And we've got to follow the rules here in terms of what should be allocated. These are going to be part of the purchase and part of getting the building up and running and therefore should be part of the capitalization of the building not expense when paid then we're going to have land improvements. Now we've got land and then land improvements. It is what it is, it's just going to be the land that the building is going to be on and it's not something that's going to depreciate.

Now things we put on the land that are going to be permanent structures like driveways fences shrubs lighting parking lots. Those are all going to be things that we're going to say are land improvements typically. And so those are going to be the type of assets we have for land improvements. We're going to depreciate over the useful life of the improvements and that's going to be an it because land doesn't typically go away but the improvements will. So whatever we do to the land we're going to we're going to if it's a typically something that's kind of like the permanently attached to the land or installed in the land in some way that basically if you sold the land he would still have the structures on it most likely then those are going to be improvements and those will deteriorate over time and therefore need to be depreciated half need to have the cost allocated.

However the land itself once purchased you don't really depreciate that the cost is what it is and it's going to be there for good. The land's not going to go away in a human lifetime hopefully. So then if we have landed another category of property plant and equipment what is included in the purchase of land. Obviously the purchase price of land. Same principles that are in play here. The title insurance. So that would be part of the cost of the land, the title insurance and the surveying fees if there's any surveying fees that would be in cost of the land and be capitalized. We've got the real estate commissions that would be a cost of the land and we've got the tidal surge and transfer also going to be a cost of the land and improvements.

Lump Sum Purchase

Within the lump sum purchase chapter of the Book we will discuss how to account for a lump sum purchase of property plant and equipment in the case where we have a purchase of something that includes multiple components but with one purchase. For example if we purchased a building and paid one lump sum price but then needed to break them out on our financial statements between the land and the building. Then how are we going to account for that. We will learn the calculations for a lump sum purchase in both a chapter as well as with an excel worksheet that we can work along with a step by step chapter to work through Excel worksheets will be pre-formatted.

So you can really work on just doing the calculations within Excel and learning some basics of Excel addition, subtraction and the relationships of cells, some of the really most important things to know and learn and excel. We will provide both a tab that will have the answers so you can go through it and look at the answer as well as an example tab so you can go through the example tab and work through the problem along with Step-By-Step chapters for it.

Property Plant & Equipment Lump Sum Purchase

In this chapter we will discuss lump sum purchases as it relates to property plant and equipment. When we purchase something like a building we typically have one lump sum purchase for more than just the building here because the building is on the land. And if we're including the land we purchased the land with the building. If there are any other lease improvements that we need to break out separately then those two would be something that we need to break out in some way. This can be a little bit difficult given the fact that we have a lump sum purchase. There are a couple of ways we can do this. We may take a look at the property tax assessments and see what the breakout was done there in order to assess property taxes. We can also take an appraisal of the property and use the appraisal in order to make this assessment.

The problem with this however is that the appraisal doesn't always match the purchase price. The appraisal may not have taken place right at the purchase price. We may not have purchased for the appraisal amount. So how then can we use the appraisal in order to create an allocation because that's the best thing we have in order to do so. Now it's also important to note that we need to break these things out, for example if we have a cost of 110000 for the purchase of the store which includes land improvements and building we need to break these things out because they have different appreciable lives. One we want to categorize them differently so that we know the value of the land versus the building and so we're going to allocate the cost over the useful life in different ways for the most part.

It doesn't depreciate. So whatever we apply to the land will remain there forever and whatever we apply to building will then depreciate over the life of the building. And that's a significant difference. So it really depends on what our objective is. When we make this allocation in terms of which would we rather have. We want to be as objective as possible but just from the perspective of the company. If you wanted to look better then you'd probably want to have land have more of the allocation because the building's going to deteriorate over time as it does so the building will decline in value on the balance sheet the balance sheet will go down and will record expenses related to that deterioration that called depreciation bringing down net income.

If on the other