Capital Market Instruments

Features of the third edition
This book is organised into seven parts. Part I sets the scene with a discussion on
the financial markets, the time value of money and the determinants of the discount
rate. Part II describes fixed income instruments, and the analysis and valuation
of bonds. This covers in overview fashion the main interest-rate models,
before looking in detail at some important areas of the markets, including
• fitting the yield curve, and an introduction to spline techniques
• the B-spline method of extracting the discount function
• bond pricing in continuous time
• inflation-indexed bonds.
We have removed the chapter on option-adjusted spread, as this is a specialist
technique and better suited to a dedicated book on fixed income. There is a new
chapter on bond credit analysis, and the various relative value measures used to
assess bond return. Part II also has a new chapter on using QuantLib to construct
a term structure model. This replaces the chapter describing the RATE yield curve
application that was included in the previous edition.
Part III is an introduction to securitisation and structured financial products,
with a look at mortgage-backed securities and collateralised debt obligations
(CDOs). New material in this chapter includes a look at securitisation post-credit
crunch, after banks started to undertake in-house deals in order to be able to
raise funding at their central bank. The chapter on CDOs has been revised and
updated.
In part IV we introduce the main analytical techniques used for derivative
instruments. This includes futures and swaps, as well as an introduction to options
and the Black-Scholes model, still widely used today over 30 years after its
introduction. Part V considers the basic concepts in equity analysis, using a
hypothetical corporate entity for case study purposes. Part VI introduces the valueat-
risk methodology, while the final part of the book is a new chapter assessing the
causes of the 2007–8 financial market crisis.

Yield curve modelling application
In the first two editions of this book we included a specialist computer application,
RATE, which was designed to introduce readers to yield curve modelling. For this
edition we have decided to use www.quantlib.org (QuantLib), or more specifically
its Excel add-in, for the purposes of demonstrating yield curve construction.
QuantLib is a free library for quantitative finance. We do not provide a detailed
description of what QuantLib does or how to use it because this can all be found
on their web site, however Chapter 11 provides additional information on term
structure construction, using QuantLib to demonstrate the concepts.