Managing Interest Rate Risk in Fixed Income Securities

This course covers bonds and money market instruments, beginning with basic concepts and the bond price between coupon payment dates, and then moving on to the repo market. It turns to zero-coupon rates, forward rates, and bond par yields: I present zero-coupon rates and forward rates, explain the derivation of zero-coupon rates from coupon-paying bonds, and demonstrate how to use forwards to calculate the expected return from investing in a bond.

In this course, I go beyond a flat term structure and analyze bond and portfolio risks under non-parallel yield curve movements. I explain why duration alone can misstate profit and loss and why convexity is necessary for tighter hedges. Students learn to compute and interpret duration and convexity between coupon dates, and then derive hedge ratios that simultaneously neutralize first- and second-order exposures. Worked examples are provided to calculate duration and convexity both between coupon dates and at the portfolio level. We connect these concepts to practice with fixed-income futures to determine duration and convexity hedge ratios when key rates twist instead of shift in parallel. I cover marking-to-market, hypothetical/deliverable bonds, conversion factors, cheapest-to-deliver, and implied repo concepts in the U.S. Treasury futures market. I also value plain-vanilla swaps and demonstrate how to use them to implement duration hedging. I provide comprehensive, step-by-step examples that tie together calculation, intuition, and execution for managing interest rate risk in bond portfolios. By the end, students will be able to identify when convexity is needed, derive and apply duration/convexity hedge ratios, and execute risk-reduction trades in futures or swaps for realistic, non-parallel yield curve changes.