Fixed Income and Interest Rate Modelling

Course	T-815-FIXE
Semester	20243
ETCS	8
Core	Yes

Year	1. year
Semester	Fall 2024
Level of course	5. Second cycle, intermediate
Type of course	Core
Prerequisites	No prerequisites.
Schedule	No schedule found.
Lecturer	Heiðar Ingvi Eyjólfsson
Content
The focus of this course is on fixed income securities. Various types of bonds will be introduced, such as fixed and variable rate bonds, zero coupon and coupon paying bonds. Also, bonds that include various options, such as equity conversion, withdrawal rights (callable bonds) and sell back rights (putable bonds) will be discussed. Various models for the term structure of interest rates will be introduced as well as techniques to construct the term structure by using a range of different interest rate instruments. Risk modelling for fixed income securities is an important activity for bond portfolios. We will demonstrate, by the use of models and examples, how value at risk, duration and convexity are applied in managing and quantifying bond portfolio risks. We will discuss the immunization of bond portfolios and the construction of bond portfolios that cover certain future cash flow liabilities. To manage inflation risk we introduce inflation indexed instruments such as bonds and swap contracts. Finally we will cover basic stochastic processes for fixed income analysis and use both binomial trees and continuous processes for the construction of some well-known interest rate models such as, Vasicek, Hull-White, Ho-Lee, and Black-Derman-Toy. These models will be applied to the construction of the term structure of interest rates and to the pricing of bonds and derivatives on interest rate instruments.
Learning outcome - Objectives
At the end of the course the student will have an appreciation of the important role fixed income and interest rate models play in financial engineering. The student will be able to apply the methods and techniques learned to a range of concrete real world problems. This learning outcome can be broken down into the following sub-outcomes: Understand different cash-flow concepts such as, present – and future values, amortization and indexation Be able to value different types of bonds with fixed and floating coupons Use important interest rate concepts such as, par yield, yield to maturity, spot rates, forward rates, infinitesimal rates and discount curves Use bootstrapping techniques to construct the term structure of interest rates from the prices of various interest rate instruments such as zero coupon bonds, coupon paying bonds, Libor and swap rate contracts Understand how structured notes with or without options are priced Use basic concepts such as duration, convexity and immunization to manage the risk of bond portfolios  Use bond immunization techniques to match assets to liabilities Understand how to price and risk manage inflation linked bonds and swap contracts Use stochastic one-factor models for the pricing of zero coupon bonds and other simple interest rate instruments Use the HJM model and Libor market models for the pricing of caps, floors, swaps and swaptions
Course assessment
Reading material
No reading material found.
Teaching and learning activities
Language of instruction	English