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This text makes accessible the most important methodological advances in bond evaluation from the past twenty years. With uncommon precision and a strong emphasis on the underlying economic fundamentals, Olivier de La Grandville presents a unified framework for understanding the basic tools of bond evaluation, including duration, convexity, and immunization. Among the book's most valuable contributions is a general immunization theorem that can be used by practitioners to protect investors against any change in the structure of spot interest rates. Also of note is the detailed presentation of the Heath-Jarrow-Morton model and a discussion of its relationships with classical immunization schemes. Each chapter is followed by a series of questions, problem sets, and projects; detailed solutions to all of them appear at the end of the book. Although the treatment is thorough and rigorous, the presentation throughout the book is intuitive.
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BOND PRICING AND PORTFOLIO ANALYSIS BOND PRICING AND PORTFOLIO ANALYSIS Protecting Investors in the Long Run Olivier de La Grandville The MIT Press Cambridge, Massachusetts London, England : 2001 Massachusetts Institute of Technology All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher. This book was set in Times New Roman on `3B2' by Asco Typesetters, Hong Kong. Printed and bound in the United States of America. Library of Congress Cataloging-in-Publication Data La Grandville, Olivier de. Bond pricing and portfolio analysis : protecting investors in the long run / by Olivier de La Grandville. p. cm. Includes bibliographical references and index. ISBN 0-262-04185-5 1. BondsÐPrices. 2. Interest rates. 3. Investment analysis. 4. Portfolio management. I. Title. HG4651.L325 2000 332.630 23Ðdc21 00-058682 For my wife, Ann, and our children, Diane, Isabelle, and Henry, and in loving memory of my mother, Anika Pataki CONTENTS Introduction ix 1 A First Visit to Interest Rates and Bonds 1 2 An Arbitrage-Enforced Valuation of Bonds 25 3 The Various Concepts of Rates of Return on Bonds: Yield to Maturity and Horizon Rate of Return 59 4 Duration: De®nition, Main Properties, and Uses 71 5 Duration at Work: The Relative Bias in the T-Bond Futures Conversion Factor 95 6 Immunization: A First Approach 143 7 Convexity: De®nition, Main Properties, and Uses 153 8 The Importance of Convexity in Bond Management 171 9 The Yield Curve and the Term Structure of Interest Rates 183 10 Immunizing Bond Portfolios Against Parallel Moves of the Spot Rate Structure 209 11 Continuous Spot and Forward Rates of Return, with Two Important Applications 221 12 Two Important Applications 237 13 Estimating the Long-Term Expected Rate of Return, Its Variance, and Its Probability Distribution 267 14 Introducing the Concept of Directional Duration 295 15 A General Immunization Theorem, and Applications 307 16 Arbitrage Pricing in Discrete and Continuous Time 327 17 The Heath-Jarrow-Morton Model of Forward Interest Rates, Bond Prices, and Derivatives 359 18 The Heath-Jarrow-Morton Model at Work: Applications to Bond Immunization 383 By Way of Conclusion: Some Further Steps 405