Chapter 4. Fixed Income Securities

In Chapter 3, Asset Pricing Models, we focused on models establishing a relationship between the risk measured by its beta, the price of financial instruments, and portfolios. The first model, CAPM, used an equilibrium approach, while the second, APT, has built on the no-arbitrage assumption.

The general objective of fixed income portfolio management is to set up a portfolio of fixed income securities with a given risk/reward profile. In other words, portfolio managers are aiming at allocating their funds into different fixed income securities, in a way that maximizes the expected return of the portfolio while adhering to the given investment objectives.

The process encompasses the dynamic modeling of the yield curve, the prepayment behavior, and the default of the securities. The tools used are time series analysis, stochastic processes, and optimization.

The risks of fixed income securities include credit risk, liquidity risk, and market risk among others...