FIN 418 B01 Fixed Income

FIN 418 B01 Fixed Income

Winter 2024 (8 January 2024 – 12 April 2024)

Keith Godfrey, [email protected]

Department of Finance

updated 10 December 2023

Introduction

This course is concerned with fixed income securities, the yield curve, interest rate risk, and tools for managing interest rate risks to maintain fixed income.

Fixed income securities markets dwarf the equity markets in terms of the dollar value of securities outstanding, as governments routinely sell billions of dollars’ worth of securities on the primary market, and secondary market transactions of less than $10 million are considered small. Despite this, the average person hears little of these markets. Very few news reports tell of how the bond market performed on a particular day, even though the movements in the bond market, through their effect on mortgage rates, consumer loan rates, and savings rates, have more impact on most peoples’ lives than the stock market gyrations that are broadcast hourly.

Any study of fixed income securities inevitably becomes technical with a lot of math and computations. The challenge is in taking the numbers, which are found mechanically, and interpreting them into statements about expectations, risks, and value. One can then apply practical techniques of portfolio management and interest rate derivative selection to build appropriate desired positions.

Learning Objectives

Upon completion, students should be able to demonstrate knowledge of working with interest rates and their conventions, inferring the term structure of interest rates and extracting information therefrom, analyzing the risk characteristics of fixed income securities including those with embedded options, describing the features of interest rate derivatives, and designing portfolios for various market outlooks.

Refer also to the broader Learning Goals of the BCom program at the Alberta School of Business at: https://www.ualberta.ca/business/programs/bachelor-of-commerce/why-bcom/learning-goals.html

Textbook and Class Materials

Textbook:	Fabozzi. Bond Markets, Analysis, and Strategies, Tenth Edition 2021, or alternatively the Ninth Edition 2015 is also okay.
Additional reading:	Fabozzi and Mann, The Handbook of Fixed Income Securities, Ninth Edition. Sundaresan. Fixed Income Markets and Their Derivatives, 3rd Edition, 2009. Hull. Fundamentals of Futures and Options Markets, 9th Edition; 2016.
Class materials:	Class materials such as lecture slides and assignment information will be placed on eClass (https://eclass.srv.ualberta.ca).

The proposed class schedule is as follows. The schedule may be modified as the semester progresses if topics take more or less time than planned. Readings and/or chapters from the text may be added or deleted at a later date. Please ensure you have read the relevant materials before each session.

Date	Topic	Readings 9 th edition	Readings 10th edition
Jan 9 Jan 11	Preliminaries. Time value of money. Interest rate quotes. Bonds. Characteristics. Pricing.	Ch. 1 Ch. 2	Ch. 1 Ch. 2
Jan 16 Jan 17	Yield. Conventions. Yield curves. (continued)	Ch. 3	Ch. 3
Jan 23 Jan 25	Duration and convexity. (continued)	Ch. 4	Ch. 4
Jan 30 Feb 1	Review First Midterm Exam (online during class)	All the above	All the above
Feb 6 Feb 8	Yield curve analysis and bootstrapping. Bond markets and conventions.	Ch. 5 Ch. 6, 7, 8, 9	Ch. 6 Ch. 7, 8, 9, 10
Feb 13 Feb 15	(continued) Teamwork Assignment dueValuing bonds with embedded options.	Ch. 18, 17	Ch. 19
Feb 20	Reading week – no classes
Feb 27 Feb 29	Spreads. Interest rate trees. Embedded options. Option adjusted spreads.	Ch. 18, 17	Ch. 19
Mar 5 Mar 7	Review Second Midterm Exam (online during class)	Second part	Second part
Mar 12 Mar 14	Bond portfolio management strategies Interest rate derivatives: Forwards and futures.	Ch. 24 Ch. 29	Ch. 24 Ch. 29, 31
Mar 19 Mar 21	FRAs. Eurodollar futures. Treasury bond futures. Interest rate options, caps and floors.	Ch. 30, 31	Ch. 30, 31
Mar 26 Mar 28	(continued) Interest rate swaps and swaptions.	Ch 31	Ch. 31
Apr 2 Apr 4	(continued) Credit ratings. Default models.	Ch. 22, 23	Ch. 22, 23
Apr 9 Apr 11	Credit derivatives. Credit default swaps. (continued) Review.	Ch. 32	Ch. 32
	Study– no classes
Apr 19	Final Exam – check BearTracks for date and location. expected to be Friday April 19 at 2:00 pm	All the above

The lecture venue is BUS 3-10 unless otherwise advised through BearTracks or eClass.

Grading

Course grades will be determined by combining points on participation, online homework assignments, two midterm exams, and a final exam. The following table shows the component marks available to students. Grades will be allocated after considering the relative performance of each student.

Participation	5% or 0%	This 5% will be awarded as the higher of your participation and your final exam. Participation will be assessed throughout the course and evaluates critical thinking and verbal communication skills as well as problem solving - not merely attendance. If you are unable to participate, or if your final exam score is higher than your participation mark, this 5% will be redistributed to your final exam.
Online Practice	10%	Online practice is provided at https://GradeChaser.com. Please register using your ualberta.ca email address (if you have had more than one uAlberta email address please ensure you use the one that is currently registered on eClass.) Your scores will be recorded three times corresponding to the midterm and final exams. The snapshot will be taken during or after each exam so that you can also use GradeChaser.com during your revision and continue to earn marks. You should complete the new topics for each exam in time for that exam. In the event that you are granted a deferred exam, you may also request that your deadline for the online practice be extended to match the deferred exam.
Assignment	5%	The teamwork assignment involves problem solving, teamwork, leadership, quantitative analysis, information processing, and written communication. Each group should make one submission. The team size can be 3, 4, or 5 students. The teamwork assignment will be available on the course website when the relevant material is covered which is at least a week prior to the deadline. Please submit your files through eClass by the deadline, noting that late submissions may receive zero without being marked.
Midterm exams (60 minutes * 2)	20%+ 20%	These assess individual critical thinking and problem solving as well as quantitative and information processing skills, and the grasp of material. The midterm exams will be online and open-book, with further details below.
Final exam(120 minutes)	40% or 45%	This assesses critical thinking and problem solving as well as quantitative and information processing skills, and the grasp of the material. The final exam covers the whole course, although with more emphasis on the portions not covered by the midterm exams. The final exam will be in-person and closed-book, with further details below.
TOTAL	100%

If your online midterm marks are significantly higher than your final exam, or if there are any anomalies with your midterm exams, I may ask you to rewrite closed-book paper midterms to demonstrate that you know the material, otherwise the midterm weights may be redistributed to the final exam.

There may be a requirement to pass the final exam in order to pass the course.

In addition to graded work, there will also be recommended end-of-chapter questions and exercises without credit for you to work on throughout the term to gain a greater understanding of the material.

Online Practice

The main purpose of the online practice at https://GradeChaser.com is to help you understand the material. You can attempt each question up to ten times and I provide detailed worked solutions.

Please ensure that you select the correct course. Click

You are welcome to explore the other courses too if you wish, but make sure you switch back.

You earn a mark for each question if at least half of your attempts are correct. You can attempt each question up to ten times. Once you have earned the mark for a question you will keep the mark even if you subsequently make more attempts for practice and get them wrong. You know that you have earned the mark for a question when you see a smile alongside the question. The symbols are:

Question not yet attempted.

Mark earned on first attempt.

Mark not yet earned. More than half the attempts so far have been incorrect.

Mark earned (at least half of your attempts were correct).

Mark retained (you keep your mark once it is earned even if subsequent additional attempts are wrong).

If you have scored the mark for at least 80% of the GradeChaser questions you will be given the full 100% for the online practice component. This means that you do not need to perfect every question to get full marks. For example, if you miss out on the mark for a question because of some minor error and you are satisfied that you know what to do, you can move on without having to redo it, and still get full marks provided you have completed at least 80% of the questions correctly.

You can tell your overall score (ensure you first select the correct course) by clicking on the entire course at the top and then reading the score on the bottom of the screen:

Please ensure you register using the same ualberta.ca address as in eClass if you have had multiple ualberta addresses. Your grade will be matched using the eClass email address.

If you already have some scores from using GradeChaser previously, you can either keep those scores or I can reset your account to zero so you can do it afresh. Contact me if you would like it reset.

Further Practice

In addition to the graded work, there are also end-of-chapter problems and exercises for you to work on throughout the term to gain a greater understanding of the material, without credit. The solutions will be placed on eClass.

Sample representative exam questions will be discussed in class prior to the examinations. Many past exam questions with randomization are available at https://GradeChaser.com.

Midterm Examinations

The midterm examinations will be held online at my web site https://KeithGodfrey.net and they will be open book and open-computer. You can access any textbooks both physically and online, including the course materials on eClass, and you can even use Google to look up anything that you like - but you must not communicate about the exam materials with anyone (except for your instructor) or any tool (such as ChatGPT) until after the exam time window has finished for everyone.

To clarify: You are welcome to look up reference material anywhere, but it is considered cheating to send any part of the exam or question related to the exam to any place that could help produce an answer.

Examples of what is acceptable and not acceptable:

Okay

• Looking up a word (e.g. fortnightly) in an online dictionary.

• Looking up a term (e.g. Black Scholes) in Google, Wikipedia, Investopedia, etc.

Not okay

x Sending a question (or asking something related) to someone else, maybe a friend, maybe an online tutoring team like Chegg or Course Hero, so that they can work towards an answer or explanation.

x Sending a question (or asking something related) to an Artificial Intelligence tool such as ChatGPT or Bard so that it can develop an answer or explanation.

The rule is that you must do the work yourself to develop your answers. That is what you are graded on.

It is cheating when someone else or something else is doing any part of that work.

It is also cheating to use any answer that has come from somewhere other than yourself (e.g. if a friend sends you an answer regardless of how they obtained it).

Unauthorized communication by any means will be prosecuted to the maximum extent of the university policy, including using materials arising from other people’s unauthorized communications. If you happen to find the questions or answers somewhere, it likely means someone is trying to cheat – please contact me immediately so this can be resolved. You should not be penalized if you declare this immediately.

The questions in our on-line exams will be designed so that the answers are not available through Googleor in the lecture notes. Online questions will typically be more numerical than theory and will require demonstration or application of theory. You need to know something about the material. The grading is based on your demonstrated knowledge.

You will need access to a PC / laptop / notebook with software including a modern web browser (such as Chrome) and Microsoft Excel or similar spreadsheet package. You will not be expected to know the advanced features of Excel – this is not a test of Excel – but you should know the basics of how to read and edit a spreadsheet if required.

Any student requiring special accommodations should contact me at least two weeks before each exam.Final Examination The final examination will be a traditional closed-book paper exam scheduled by the university.

You may bring pencils, pens, calculator(s), and transparent bottled water. You must display your ONECard identification on your desk.

Closed book means that no books or notes of any kind are allowed. A formula sheet will be provided to you in the examination. The formula sheet will be discussed in class and shown in advance on eClass (but do not bring your own copy – it will be provided to you).

Computers, notebooks, laptops, tablets, and any devices with communication facilities are not allowed.

Programmable calculators must be "de-programmed" before exams. You can bring multiple calculators (for example both a financial calculator and a scientific calculator) provided that each calculator is deprogrammed. If you want to retain programmed information then you should bring a different calculatorto the exams. Ensure that you know how to drive your calculator(s) and that your batteries have sufficientpower. A financial calculator can be useful but is not essential. A calculator that has y x , e x , and ln(x) functions should be sufficient.

Missed Assessments and Deferred Exams

The rules for attendance and absence from term work and examinations are specified in the Academic

Regulations (http://calendar.ualberta.ca/content.php?catoid=6&navoid=806). If you miss, or if you know you are going to miss any term work or exam for a reason that is acceptable to the university (such as an incapacitating illness, a severe domestic affliction, a religious belief, and so on) then please providesupporting evidence as soon as possible. You will receive a mark of zero in a missed assessment unlessappropriate supporting documentation is received in a timely manner.

If you miss online practice or a teamwork assignment for a reason that is acceptable to the university, please supply supporting documentation to me within two days (or as soon as practical in cases of extenuating circumstances). With evidence provided in time, the deadline for the online practice can be changed or the weight from the missed assignment may be redistributed to the other components.

If you miss a midterm exam for a reason that is acceptable to the university, please supply supporting documentation to me within two days (or as soon as practical in cases of extenuating circumstances).

With evidence provided in time, the weight from the missed exam may be redistributed to the other exams.

If you miss the final exam for a reason that is acceptable to the university, please contact your faculty office promptly in accordance with the University Regulations and the Information for Students in the

University Calendar. The office will decide whether to award a deferred final exam.

The deferred final exam will be held on Tuesday 4 June 2024 at 1:30pm unless an alternativearrangement is agreed.

Disagreements with Assessments

Your grades will stand as posted online unless any mistakes are drawn to my attention in a timely manner.

Grades will normally be available within one business week of exams. Once a final grade is assigned, itwill not be changed except in the case of a recording error. If you feel that any midterm or final grade isincorrect, please notify me by email within one week from the posting of the grades online (or as soon as practical in cases of extenuating circumstances). Please note that any query about an exam mark willnormally result in the entire exam being remarked which may lead to your mark going up or down. I may send your paper for remarking by a different marker, or I may invite you to witness me remarking the paper if your perception of your mark is substantially different from mine.

Office Hours and Email

My office hours will initially be Thursdays 11:00 to 12:00 in room 1.23(b) and will initially be shared with all my courses. Any changes and additional times will be posted on eClass. I am also usually available after each class and otherwise by appointment.

My email addresses are [email protected] for course matters and [email protected] for any issues with the online practice. I normally respond to emails within two business days or faster. In the subject line please include the course, and please include your name in the email.

Please use your university email address. Emails sent to any ualberta address from non-university accounts risk being rejected by the university’s spam filter and might never be received or read.

University of Alberta Rules

Policy about course outlines can be found in Course Requirements, Evaluation Procedures and Gradingof the University Calendar.

The University of Alberta is committed to the highest standards of academic integrity and honesty.

Students are expected to be familiar with these standards regarding academic honesty and to uphold thepolicies of the University in this respect. Students are particularly urged to familiarize themselves with the provisions of the Code of Student Behaviour (online at www.governance.ualberta.ca) and avoid anybehaviour which could potentially result in suspicions of cheating, plagiarism, misrepresentation of factsand/or participation in an offence. Academic dishonesty is a serious offence and can result in suspension or expulsion from the University.

Audio or video recording, digital or otherwise, of lectures, labs, seminars or any other teaching environment by students is allowed only with the prior written consent of the instructor or as a part of anapproved accommodation plan. Student or instructor content, digital or otherwise, created and/or usedwithin the context of the course is to be used solely for personal study, and is not to be used or distributedfor any other purpose without prior written consent from the content author(s).