Fixed Income Analytics: Bonds in High and Low Interest Rate Environments PDF
Preview Fixed Income Analytics: Bonds in High and Low Interest Rate Environments
Wolfgang Marty Fixed Income Analytics Bonds in High and Low Interest Rate Environments Fixed Income Analytics Wolfgang Marty Fixed Income Analytics Bonds in High and Low Interest Rate Environments WolfgangMarty AgaNolaAG Pfaeffikon Switzerland ISBN978-3-319-48540-9 ISBN978-3-319-48541-6 (eBook) DOI10.1007/978-3-319-48541-6 LibraryofCongressControlNumber:2017952064 #SpringerInternationalPublishingAG2017 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpartof the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilarmethodologynowknownorhereafterdeveloped. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesareexempt fromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. Thepublisher,theauthorsandtheeditorsaresafetoassumethattheadviceandinformationinthis book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained hereinor for anyerrors oromissionsthat may havebeenmade. Thepublisher remainsneutralwith regardtojurisdictionalclaimsinpublishedmapsandinstitutionalaffiliations. Printedonacid-freepaper ThisSpringerimprintispublishedbySpringerNature TheregisteredcompanyisSpringerInternationalPublishingAG Theregisteredcompanyaddressis:Gewerbestrasse11,6330Cham,Switzerland Foreword In light of an investment environment characterized by low yields and new regu- latory capital regimes, it has become increasingly demanding for investors to achieve sustainable returns. Particularly, fixed income investments are called into question.Thereisasolution. Since the foundation of AgaNola a decade ago, we have put our interest into convertibles,andatthispointwewanttothankourclientsforhavingsupportedus alsoinchallengingtimes—particularlywhenconvertiblebondswereconsideredat mostanicheinvestment.Unjustly! For being a hybrid, convertible bonds offer the “best of both worlds,” the benefitsofanequitywiththeadvantagesofacorporate bond.AgaNolaisconsid- eredaleadingproviderinthisassetclass,andtodateconvertiblebondsremainthe corecompetenceofusasaspecializedassetmanager. As we consider increasingly popular convertible bonds a living and dynamic universe,weareplacingagreatimportanceonresearchandtheexplorationofthe natureofthisassetclass.Asaninternationallyrenownedexpertinthefixedincome and bond field, Dr. Wolfgang Marty has contributed valuable insights to our work—making the bridge from theory to portfolio management. AgaNola is committedtocontinuetosupporthisfundamentalresearch. WewishWolfgangMartylotsofsuccesswithhislatestbook. ChairmanandFounderAgaNolaAG StefanHiestand v Foreword Comparedtootherassetclasses,fixedincomeinvestmentsareroutinelyconsidered as a relatively well-understood, transparent, and (above all) safe investment. The notionsofyield,duration,andconvexityarereferredtoconfidentlyandresolutely inthecontextofsinglebondsaswellasbondportfolios,andtheeffectsofinterest ratesaregenerallybelievedtobewell-understood. Atthesametime,weliveinaworldwheretheamountofprivate,corporate,and sovereigndebtissteadilyincreasingandwherepostcrisisstimulicontinuetoaffect and distort investor behavior and markets in an unprecedented way. And that is even before we start contemplating the enormous uncertainties introduced by negativeinterestrates. In his book, Dr. Wolfgang Marty covers and expands on classic fixed income theoryandterminologywithaclarityandtransparencythatisraretobefoundina world where computerization of accepted facts often is the norm. Wolfgang highlights obvious but commonly unknown conflicts that can be observed, for example,whenapplyingstandardtheoryoutsideitsdefaultsettingorwhenmigrat- ingfromsingletomultiplebondportfolios.Healsoincludestheeffectsofnegative interestratesintostandardtheory. Wolfgang’sbookmakeshighlyinformativereadingforanyoneexposedtofixed income concepts, be it as a portfolio manager or as an investor, and it shows that often we understand less than we think when studying bond or bond portfolio holdings purely based on their commonly accepted key metrics; Wolfgang encourages to ask questions. Anyone building automated software would benefit from familiarity with the model discrepancies highlighted as it is to everyone’s disadvantage if we find these too deeply rooted in commonly and widely applied tools. In summary, Wolfgang’s book makes interesting reading for the fixed income noviceaswellastheseasonedpractitioner. HeadofQuantitativeResearch Dr.JanHendrikWitte RecordCurrencyManagement vii Preface Computershavebecomemoreandmorepowerfulandoftenareaninvaluableaid. Butthereisaconsiderabledisadvantage:often,theoutputofacomputerprogramis difficult to understand, and the end user may be swamped by data. In addition, computerssolveproblemsinmanydimensions,and,ashumanbeings,westruggle thinking in more than a few dimensions. To provide a sound background of understanding toanyone working infixedincome, we intend toillustrate here the essentialbasiccalculations,followedbyeasytounderstandexamples. The reporting of return and risk figure is paramount in the asset management industry,andtheportfoliomanagerisoftenrewardedonperformancefigures.The firstmotivationfortheherepresentedmaterialwerethefindingsofaworkinggroup of the Swiss Bond Commission (OKS), where we compared the yield for a fixed income benchmark portfolio calculated by different software providers: we found different yields for the same portfolio and the same underlying time periods. The following questions are obvious: How can a regulating body accept ambiguous figures?Shouldtherenotbeastandard? An additional complication is linearization, often the first step in analyzing a bond portfolio. The yield of the bonds in a bond portfolio is routinely added to report theyieldofthetotalbondportfolio,anddifferentdurationsofbondsinthe portfolio are simply added to indicate the duration of a bond portfolio. We found thatlinearizationworkswellforaflatyieldcurve,butthemoretheyielddeviates fromaflatcurve,themoretheresultingfiguresbecomequestionable. Also, historically, interest rates have been positive. In the present market conditions, however, interest rates are close to zero or even slightly negative. We find ourselves confronted with several questions: Does the notion of duration still make sense in this new environment? And which formulae can be applied for interest rates equalorvery close tozero? Howdodiscountfactorsbehave?Inthe following, we attempt to include negative interest in our considerations. For instance, in the world of convertibles, yield to maturities can easily be negative andisnotproblematic. ix x Preface Wedescribetheherepresentedmaterialinthreeways.Firstly,weusewordsand sentences,inordertogiveanintroductionintointhenotions,definitions,ideas,and concepts.Secondly,weintroduceequations.Thirdly,wealsousetablesandfigures inordertomaketheoutputsofournumericalcalculationsaccessible. PfaeffikonSZ,Switzerland WolfgangMarty July18,2017 Acknowledgments Thisbookisbasedonseveralpresentations,courses,andseminarsheldinEurope andtheMiddleEast.Theherepresentedmaterialisbasedonacompilationofnotes andpresentations.PresentingfixedincomeisauniqueexperimentandIamgrateful forthemanyfeedbacksfromtheaudience.Theinitialmotivationforthebookwasa seminar held at the education center of the SIX Swiss Exchange. I became aware thatmanyissuesinfixedincomeneedtoberestudiedandrevised;moreover,Idid not find satisfying answers to my questions in the pertinent literature. The SIX Swiss Exchange Bond Advisory Group was an excellent platform for analyzing openissues. Furthermore,theworkinggroup“PortfolioAnalytics”oftheSwissBondCom- mission was instrumentalforthe researchactivities.Inparticular mythanksgoto Geraldine Haldi, Dominik Studer, and Jan Witte. They revised part of the manu- scriptandprovidedhelpfulcomments. TheEuropeanBondCommission(EBC)wasveryimportantformyprofessional development. The members of the EBC Executive Committee Chris Golden and Christian Schelling gave me continuing support for my activities, and the EBC sessionsthroughoutEuropeyieldedimportantideasforthebook. AtthemomentIamfocusingonconvertibles.MythanksgotoMarcoTurinello and Lukas Buxtorf for introducing me into the analytics of convertibles. The last chapterofthebookisdedicatedtoconvertibles. The book was written over several years, and I am grateful to my present employerAgaNolafortheopportunitytocompletethisbook. xi Conventions Thisbookconsistsofeightchapters.Thechaptersaredividedintosections.(1.2.3) denotesformula(3)inSect.1.2.Ifwerefertoformula(2)inSect.1.2,weonlywrite (2); otherwise we use the full reference (1.2.2). Within the chapters, definitions, assumptions,theorems,andexamplesarenumeratedcontinually,e.g.,Theorem2.1 referstoTheorem1inChapter2. Squarebrackets[]containreferences.Thedetailsofthereferencesaregivenat theendofeachchapter. xiii
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