Advanced Interest Rate Models - Construction, Implementation and Applications

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 Introduction to Interest Rate Modelling

• Interest Rates and their Behaviour
• The Term Structure of Interest Rates
• The Term Structure of Volatility
• Features of Interest Rate Models
  • One or two factors
  • No-arbitrage
  • Mean reversion
  • Spot or forward rates

Equilibrium Models

• Rendleman and Barter
• Vasicek
  • Mean reversion in the Vasicek model
  • Term structures in the Vasicek Model
• Cox, Ingersoll, & Ross (CIR)
  • General form of CIR
  • Mean reversion in the CIR model
  • Term structures in the CIR model
• Examples and Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 No-arbitrage Models

• Markov vs. Non-Markov Models
• The Ho and Lee Model
• The BDT Model
  • General form
  • Deriving the model from zero curve and volatility structure
• The Hull-White Model
  • A general tree-building procedure
  • Building the tree – stage one
  • Calculating branching probabilities
  • Building the tree – stage two
• The Swap Market Model
• The Libor Market (BGM) Model
• Using Monte Carlo Simulation with Interest Rate Models
• Exercises

Day Two

09.00 - 09.15 Recap

09.15 - 12.00 Pricing Interest Rate Options Using Term Structure Models

• Pricing Options on Zero Coupon Bonds
• Pricing Options on Coupon-Bearing Bonds
• Pricing Libor Options
  • Interest Rate Guarantees
  • Caps and Floors
  • Swaptions
  • “Cancellation Swaps”
• Pricing Structured Interest Rate Products
  • “Capped FRNs”
  • “Inverse Floaters”
  • “Callable Snowball Notes”
  • “Targeted Redemption Notes”
  • “Fairway Bonds”
• Pricing Exotic Structures
  • Captions, floptions and other compounds
  • Ratchet caps, sticky caps, and flexi caps etc.
• Examples and Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Pricing Callable and Defaultable Bonds

• Pricing Callable Bonds
  • Single-call and multiple-call bonds
• Prepayment Models
  • Integrating Prepayment Models into an Interest Rate Model
• Pricing Defaultable Bonds
  • Incorporating credit spreads into term structure models
• Examples and Exercises

Using Interest Rate Models in Risk Management

• Hedging Instruments and Hedging Process
• Calculating Key Ratios and Hedge Ratios
• Generating Return Distributions and Calculating “Value-at-Risk”

Evaluation and Termination of the Seminar