Fixed-Income Securities - Finance Theory, MIT Lecture 4-6

15.401




15.401 Finance Theory
MIT Sloan MBA Program



Andrew W. Lo
Harris & Harris Group Professor, MIT Sloan School

Lectures 4–6: Fixed-Income Securities


© 2007–2008 by Andrew W. Lo

, Critical Concepts 15.401

ƒ Industry Overview
ƒ Valuation
ƒ Valuation of Discount Bonds
ƒ Valuation of Coupon Bonds
ƒ Measures of Interest-Rate Risk
ƒ Corporate Bonds and Default Risk
ƒ The Sub-Prime Crisis

Readings
ƒ Brealey, Myers, and Allen Chapters 23–25




© 2007–2008 by Andrew W. Lo Slide 2
Lectures 4–6: Fixed-Income Securities

, Industry Overview 15.401


Fixed-income securities are financial claims with promised cashflows of
known fixed amount paid at fixed dates.
Classification of Fixed-Income Securities:
ƒ Treasury Securities
– U.S. Treasury securities (bills, notes, bonds)
– Bunds, JGBs, U.K. Gilts
– ….
ƒ Federal Agency Securities
– Securities issued by federal agencies (FHLB, FNMA $\ldots$)
ƒ Corporate Securities
– Commercial paper
– Medium-term notes (MTNs)
– Corporate bonds
– ….
ƒ Municipal Securities
ƒ Mortgage-Backed Securities
ƒ Derivatives (CDO’s, CDS’s, etc.)

© 2007–2008 by Andrew W. Lo Slide 3
Lectures 4–6: Fixed-Income Securities

, Industry Overview 15.401




U.S. Bond Market Debt 2006 ($Billions)


Asset-Backed, Municipal,
2,016.70, 8% 2,337.50, 9%
Money Treasury,
Markets, 4,283.80, 16%
3,818.90, 14%

Federal
Agency,
2,665.20, 10%

Mortgage-
Corporate, Related,
5,209.70, 19% 6,400.40, 24%




© 2007–2008 by Andrew W. Lo Slide 4
Lectures 4–6: Fixed-Income Securities