I Preliminaries 15
1 Introduction 17
2 Money, credit and banking 25
2.1 Abstract properties of money 25
2.2 Early forms of money 27
2.2.1 Paper money and bank notes 31
2.3 Fiat money 32
2.3.1 Fiat money and trade 33
3 Banks 35
3.1 Banks and bank money creation 35
3.2 Categories of banks 36
4 Bank money creation 39
4.1 Single-bank introduction 39
4.2 Extension to multiple banks 42
4.3 Transfer settlement in central bank money 46
4.4 Trade and non-bank credit 50
4.4.1 Non-cash trading instruments 51
4.4.2 Discounting 52
4.4.3 Delineating payment instruments from money 52
4.5 Digital token monies and cryptocurrencies 53
4.6 The money multiplier 54
5 The role of central banks 57
5.1 Introduction 57
5.2 Monetary financing 63
6 Monetary policy 65
6.1 Objectives of monetary policy 65
6.2 Monetary policy under inflation targeting 68
6.3 Central bank operational frameworks 72
6.3.1 Symmetric interest rate corridors 74
6.3.2 Asymmetric lending corridors 76
7 Operational frameworks 77
7.1 Control of the money supply 77
7.2 Liquidity provision: Rediscounting, outright purchases and Lombard lending 78
7.3 Liquidity absorption: Asset sales and reverse repos 79
7.4 The impact of FX operations 80
8 Interaction between frameworks and policy 83
8.1 Volatility 83
8.2 Collateral 84
9 Non-standard monetary policy 87
9.1 Quantitative easing 87
9.1.1 The monetary effect of large-scale asset purchases 92
9.1.2 Market liquidity and central bank asset purchases 93
9.1.3 Helicopter money 95
9.1.4 Choice of methods and assets 96
9.2 Practical experience 99
9.2.1 QE, money multipliers and FX 99
9.2.2 Bank of Japan 2013 QE experience 104
9.2.3 Lessons from the initial BoJ quantitative easing 106
9.3 Negative interest rates 108
9.4 The specific situation of the ECB 109
II Cash instruments 113
10 Contract and instrument types 115
10.1 Securities and bilateral contracts 115
10.2 Security identifiers 118
10.2.1 ISIN codes 118
10.2.2 CUSIP codes 120
11 Trading and settlement 123
11.1 Trading 123
11.1.1 Trading and price formation 123
11.1.2 Trading venues 124
11.1.3 The OTC trade lifecycle 126
11.1.4 The exchange trade cycle 137
11.1.5 Trading in competition versus single dealer inquiries and orders 137
11.2 Settlement 139
11.2.1 Settlement mechanisms 139
11.2.2 Settlement conventions 140
12 Central clearing 143
12.1 Direct clearing 143
12.2 Indirect clearing 149
12.2.1 Agency clearing 149
12.2.2 Principal clearing 150
12.2.3 Hybrid clearing models 150
12.3 Contract value adjustments (xVA) 151
12.3.1 Credit Value Adjustment 152
12.3.2 Funding Value Adjustment 152
12.3.3 Debit Value Adjustment 153
13 The money market 155
13.1 Money market instruments 155
13.2 Discount factors 157
13.3 Daycount conventions 158
13.4 Money market interest rates 160
13.5 Compounding 161
13.6 LIBOR, Euribor, and friends 162
13.7 Overnight benchmarks 164
13.8 Benchmark reform 165
13.9 Money market futures and futures trading 167
13.9.1 Money market futures 167
13.9.2 Identification of futures contracts 168
13.9.3 Futures trading basics 169
13.9.4 Convexity adjustment 170
14 The repo market 173
14.1 The repurchase market 173
14.2 Haircut 175
14.3 Variations of repurchase transactions 176
14.4 Rehypothecation 178
15 Spot and forward rates 179
15.1 Forward rates 179
15.2 No-arbitrage calculations 179
15.3 Official rates versus term rates 181
15.3.1 The turn premium 182
15.3.2 Matching policy expectations to market rates 183
16 Bond market 187
16.1 Introduction 187
16.2 Cashflow types 188
16.2.1 Bullet bonds 188
16.2.2 Zero coupon bonds, perpetuals and annuities 190
16.3 Issuer types 194
16.3.1 Joint issuance 196
16.3.2 Supranationals 199
16.4 Governing law and contractual clauses 200
16.5 Bond markets 203
16.5.1 The primary market 206
16.5.2 The secondary market I: (interdealer market) 211
16.5.3 The secondary market II: (customer-facing market) 212
16.6 Accrued interest 212
16.7 Yield 214
16.7.1 Running yield 214
16.7.2 Simple yield 214
16.7.3 Compound yield 215
16.7.4 Bond-equivalent yield 216
16.8 Interest rate risk 217
16.9 Convexity 219
16.10Bond value decomposition 220
16.11Carry 223
17 Floating-rate notes 225
17.1 Coupon reset mechanics 226
17.2 Libor and OIS-linked notes 227
17.3 Discount margin 229
17.4 CMS and CMT floaters 231
18 Asset markets and liquidity 233
18.1 Concepts 233
18.2 Liquidity measurement 237
18.2.1 Taxonomy of liquidity measures 239
18.3 Examples 241
18.4 Liquidity premium 244
18.5 Liquidity and volatility 246
19 Curves and curve models 249
19.1 Models 250
19.2 Yield curve representation and interpretations 251
19.2.1 Discount factors versus par curves 251
19.3 Market-based curve representations 254
19.3.1 Bootstrapping 254
19.3.2 Reverse bootstrapping 256
19.4 Parametric curve models 257
19.4.1 The Nelson-Siegel and Nelson-Siegel-Svensson spline 258
19.4.2 Polynomial splines 259
19.4.3 The exponential spline 261
19.4.4 The Vasicek spline 261
19.4.5 Composite models 264
19.5 Fitting curve models 265
20 Curve analyis 269
20.1 Expectations 270
20.2 Convexity bias 274
20.3 Term risk premium 276
20.4 Preferred habitat 278
20.4.1 Asset-liability matching 278
20.4.2 Regulatory constraints 279
20.4.3 Passive investing 280
20.4.4 Central bank reserve portfolios 281
20.4.5 Market technicals 281
21 Carry and roll-down 283
22 Curve spreads 287
22.1 Z-spread 287
22.2 Par spread 288
22.3 Swap spreads 289
22.3.1 Asset swap spreads 289
22.3.2 I-spreads 291
22.3.3 The TED spread 292
III Inflation-linked debt 293
23 Inflation-indexed bonds 295
23.1 Introduction 295
23.1.1 Cashflows of inflation-linked bonds 298
23.1.2 Quotation of index-linked bonds 300
23.2 Rebalancing, rebasing and revision of CPI indices 301
23.3 Inflation seasonality 304
23.4 Price formation in inflation-linked markets 308
23.5 Return measures of inflation-linked bonds 310
23.6 Breakeven inflation 312
23.7 Carry on inflation-indexed bonds 315
23.8 Comprehensive inflation modelling 316
23.9 Inflation models and expectations 321
IV Defaultable claims 325
24 Credit risk 327
24.1 Default, insolvency, and bankruptcy 327
24.2 Seniority and subordination 328
24.2.1 Time subordination and acceleration 328
24.2.2 Contractual subordination 329
24.2.3 Statutory subordination 330
24.2.4 Joint liabilities and credit support 331
24.2.5 Sovereign debt 331
24.3 The default process 332
24.3.1 Collective action clauses 334
24.3.2 Debt exchanges and consent solicitations 335
24.3.3 Managed defaults 336
24.3.4 Wind-downs 337
24.4 Credit ratings 337
24.4.1 Rating migration 340
24.4.2 Alternative rating approaches 345
25 Covered bonds 347
25.1 Statutory covered bonds 353
25.2 Danish covered bonds 356
25.3 Structured covered bonds 357
25.4 Covered bond credit risk analysis 359
26 Asset-backed securities 363
26.1 The ABS issuance process 364
26.2 Default risk of ABS 365
26.3 Maturity of ABS 367
27 Residential mortgage-backed securities 369
27.1 Residential mortgage prepayments 370
27.2 Prepayment modelling 373
V Derivatives 381
28 Bond futures 383
28.1 Introduction 383
28.2 Futures trading patterns 386
28.2.1 Open interest and trading volume 386
28.2.2 CFTC data for US futures contracts 390
28.3 Valuation of physically delivered bond futures 394
28.3.1 Basis and implied repo rate 394
28.3.2 Conversion factors and the notional coupon 396
28.3.3 The cash-and-carry arbitrage 399
28.3.4 The quality option 400
28.3.5 Hedging with futures 401
28.4 Futures rolls 407
28.4.1 Roll ratios 410
28.4.2 Advanced futures delivery models 413
28.5 Delivery windows 413
28.6 Interaction between futures and bonds 415
28.7 Futures squeezes 416
28.8 Cash-settled futures 419
28.8.1 Exchange-for-physical transactions 420
28.9 New bond issues 421
29 Swaps 423
29.1 Introduction 423
29.2 Plain vanilla swaps 426
29.3 Trade compression and re-couponing 428
VI Standard trading strategies 431
30 Trading principles 433
30.1 Definitions 433
30.2 Trade identification 436
30.3 Trade portfolios 437
31 Curve trading 439
31.1 Simple curve trades 443
31.1.1 Outright trades 443
31.1.2 Steepeners and flatteners 443
31.1.3 Butterflies 446
31.1.4 Condors 447
31.2 Intrinsic curve movements 448
31.2.1 Alternative specifications 454
32 Bond trading 457
32.1 Bond relative value 457
32.2 Relative value strategies 459
32.2.1 Spread widener/tightener 459
32.2.2 Basis trade 460
32.2.3 Bond spread 461
32.2.4 Bond spread with curve hedge 461
32.2.5 Alternative strategies 462
33 Principal Component Analysis 465
33.1 PCA as generalised regression 468
33.2 Measuring data complexity with PCA 469
34 Bond index mechanics 473
34.1 Bond index principles 473
34.2 Index rebalancing 475
35 Portfolio risk management 477
35.1 Risk-neutral portfolios 477
35.2 Index tracking 480
35.2.1 Friction effects 484
36 Hedging 487
36.1 Introduction 487
36.2 Duration-neutral hedges 488
36.3 Regression hedges 489
36.4 Yield curve model hedges 490
37 Mean-variance optimisation 495
38 Portfolio rebalancing 505
38.1 Passive and semi-passive strategies 506
38.1.1 No reallocation 506
38.1.2 Passive management 506
38.1.3 Index replication 507
38.1.4 Constant asset allocation 508
38.1.5 Trend following 509
38.1.6 Mean reversion 509
38.2 Numerical examples 510
VIII References 513
39 Selected global bond markets 515
39.1 Euro area 515
39.1.1 Austria 517
39.1.2 Belgium 518
39.1.3 Finland 519
39.1.4 France 519
39.1.5 Germany 522
39.1.6 Greece 525
39.1.7 Ireland 526
39.1.8 Italy 527
39.1.9 The Netherlands 529
39.1.10 Portugal 530
39.1.11 Spain 531
39.2 Iceland 532
39.3 Japan 533
39.4 Sweden 536
39.5 United Kingdom 537
39.6 United States of America 539