Mastering Investment Banking Securities A practical guide to structures, products, pricing and calculations NATASHA KOZUL Financial Times Prentice Hall is an imprint of Harlow, England London New York Boston San Francisco Toronto Sydney Singapore Hong Kong Tokyo Seoul Taipei New Delhi Cape Town Madrid Mexico City Amsterdam Munich Paris Milan
Foreword The aim of the book Introduction Part 1 STRUCTURES xi xii xiv l 1 Investment bank divisions 3 Mergers and acquisitions (M&A) 4 Capital markets (CM) 7 Securitisation 9 Sales and trading 11 2 Investment bank organisational structure 13 Front office 14 Middle office 18 BackOffice 21 Part 2 MONEY MARKETS AND CAPITAL MARKETS INSTRUMENTS 23 3 Money market products 25 Time value of money 26 Nominal and effective rates 28 Cashflow analysis 32 Overview of money market products 34 Money market calculations 36 4 Capital markets instruments 39 Overview of capital markets instruments 40 Bond pricing fundamentals 42 Other bond markets 49
Part 3 FINANCIAL DERIVATIVES 51 5 Speculative f inancialinstruments - derivatives 53 Overview of derivatives markets 54 Users of derivatives 57 Interest rate derivatives 58 Equity derivatives 60 Commodity derivatives " 61 Credit derivatives 62 6 Financial futures and forward rate agreements (FRAs) 65 Financial futures 66 Forward rate agreements (FRAs) 70 Futures vs. FRAs 71 7 Swaps 73 Basic swap concepts and applications 74 Types of swaps 76 Swap pricing fundamentals 79 Pricing currency swaps 82 Equity swap valuation 84 8 Foreign exchange 87 Spot exchange rates 88 Direct and cross-rates 89 Forward exchange rates 91 9 Options 97 Motivation behind option trading 98 Option contract specifications 98 Types of option contracts 99 Option contract risks and benefits 102 Ideas behind option pricing 102 Put-call parity 104 Option value sensitivities 'option Greeks' 106 Option pricing: practical implementation 109 10 Bond and equity derivatives 121 Introduction to bond derivatives 122 Background on equity markets 125
11 Commodityand credit derivatives 135 Background on commodity derivatives 136 Introduction to credit derivatives 138 12 OTC derivatives and hybrid securities 145 OTC derivatives 146 Hybrid securities 150 Part 4 PRICING AND VALUATION TOOLS 15 5 13 Probability and statistics 15 7 Definition of probability 158 The main concepts of probability 158 The concept of probability distribution 162 Types of probability distribution 164 Binomial distribution 164 Normal distribution 166 Log-normal distribution 169 Other probability distributions 171 Binomial trees 172 14 Yield curves 175 Choice of financial instruments for yield curve construction 177 Yield curve construction methodology 179 The one-month curve construction 184 The basis curve construction 185 Shape of the yield curve 188 Graphical yield curve representation 189 15 Quantitative analytics 191 Role of quantitative analytics 192 Classification of pricing models 192 Numerical methods 193 Analytical methods 196 16 Summary of pricing formulae 205 Notation 206 Time value of money 206 Money markets calculations 208 Capital markets instruments 208 Financial futures 210
Forward rate agreements (FRAs) 211 Interest rate swaps 212 Foreign exchange 212 Option characteristics 215 Option pricing 216 Bond derivatives 218 Equity derivatives 219 Probability and statistics 221 Yield curves 223 Part 5 RISK MANAGEMENT 227 17 Credit risk on derivatives 229 Counterparty risk 230 Product risk 230 Credit risk of specific financial instruments 231 Credit ratings 234 Credit risk management 235 Credit risk management best practice guidelines 237 18 Market risk on derivatives 239 Balance sheet vs. off-balance sheet instruments 240 Market risk on specific financial instruments 241 Market risk management 245 Market risk management best practice guidelines 246 Value at risk (VAR) 248 Appendices 1 Option strategies 255 2 ISO (SWIFT) currency codes 271 Glossary 277 Bibliography 297 Index 299