, Instructor’s Manual
for
Bond Markets, Analysis, and Strategies
10th Edition
by
Rob Hull
Washburn University School of Business
The MIT Press
Cambridge, Massachusetts
London, England
© 2021 Massachusetts Institute of Technology 1
, OVERVIEW OF CONTENTS
Chapter 1 introduces the fundamental features of bond, the type of issuers, and risk faced by
investors in fixed-income securities. Chapters 2–6 set forth the basic analytical framework
necessary to understand the pricing of bonds and their investment characteristics. The theory and
history of interest rates is also covered. Chapter 7 presents Treasury securities, Treasury
derivative securities, and federal agency securities. Chapters 8–10 provides details on the
investment characteristics and special features of U.S. corporate debt, municipal securities, and
non-U.S. bonds. Chapters 11–14 focus on residential mortgage-backed securities. Chapter 15
covers commercial mortgage loans and commercial mortgage-backed securities. Chapter 16
looks at asset-backed securities and Chapter 17 introduces pooled investment vehicles for fixed-
income investors. Chapter 18 covers the liquidity and trading of credit/spread products, while
Chapter 19 explains how to analyze bonds with embedded options. Chapter 20 analyzes
residential mortgage–backed securities, while Chapter 21 covers convertible bonds. Chapter 21
discusses measuring the credit spread exposures of corporate bonds. Chapter 22 analyzes the
corporate bond credit analysis and Chapter 23 provides the basics of credit risk modeling.
Chapters 24–26 covers bond portfolios in regards to its strategies, construction and management.
Chapter 27 investigates liability-driven investing for defined benefit pension plans. Chapter 28
examines bond performance measurement and evaluation. Chapters 29–30 covers interest-rate
futures contracts and interest-rate options. Chapter 31 examines interest-rate swaps, caps, and
floors while Chapter 32 investigates credit derivatives.
CHAPTER 1
INTRODUCTION
CHAPTER SUMMARY
This introductory chapter will focus on the fundamental features of bond, the type of issuers, and
risk faced by investors in fixed-income securities. A bond is a debt instrument requiring the
issuer to repay to the lender the amount borrowed plus interest over a specified period of time.
A typical (“plain vanilla”) bond issued in the United States specifies (1) a fixed date when the
amount borrowed (the principal) is due, and (2) the contractual amount of interest, which
typically is paid every six months. The date on which the principal is required to be repaid is
called the maturity date. Assuming that the issuer does not default or redeem the issue prior to
the maturity date, an investor holding this bond until the maturity date is assured of a known cash
flow pattern. Since the early 1980s a wide range of bond structures has been introduced into the
bond market.
SECTORS OF THE U.S. BOND MARKET
The U.S. bond market is divided into six sectors: U.S. Treasury, agency, municipal, corporate,
asset-backed securities, and mortgage. Bond investors consider these sectors when deciding on
their investment strategies.
© 2021 Massachusetts Institute of Technology 2
, The Treasury Sector
The Treasury sector includes securities issued by the U.S. government. These securities include
Treasury bills, notes, and bonds. This sector plays a key role in the valuation of securities and the
determination of interest rates throughout the world.
The Agency Sector
The agency sector includes securities issued by federally related institutions and government-
sponsored enterprises. The securities issued are not backed by any collateral and are referred to
as agency debenture securities.
The Municipal Sector
The municipal sector is where state and local governments and their authorities raise funds. This
sector is divided into two subsectors based on how the interest received by investors is taxed at
the federal income tax level: the tax-exempt and taxable sectors. The municipal bond market
includes two types of structures: tax-backed and revenue bonds.
The Corporate Sector
The corporate sector includes (i) securities issued by U.S. corporations and (ii) securities issued
in the United States by foreign corporations. Issuers in the corporate sector issue bonds, medium-
term notes, structured notes, and commercial paper. The corporate sector is divided into the
investment grade and noninvestment grade sectors.
The Asset-Backed Securities Sector
In the asset-backed securities sector, a corporate issuer pools loans or receivables and uses the
pool of assets as collateral for the issuance of a security. Captive finance companies (subsidiaries
of operating companies that provide funding for loans to customers of the parent company) are
typically issuers of asset-backed securities.
The Mortgage Sector
The mortgage sector is the sector where securities are backed by mortgage loans. The mortgage
sector is divided into the residential mortgage sector and the commercial mortgage sector. The
residential mortgage sector includes loans for one- to four-family homes. The commercial
mortgage sector covers commercial loans for income-producing property.
Bond Investors
Bond investors (including retail investors and institutional investors) have an opportunity to
invest in a pooled investment vehicle in lieu of constructing their own portfolio to obtain
exposure to the broad bond market and/or specific sectors of the bond market. For retail
investors, the benefits of investing in pooled funds are improved means for diversification,
liquidity, and professional management.
© 2021 Massachusetts Institute of Technology 3
for
Bond Markets, Analysis, and Strategies
10th Edition
by
Rob Hull
Washburn University School of Business
The MIT Press
Cambridge, Massachusetts
London, England
© 2021 Massachusetts Institute of Technology 1
, OVERVIEW OF CONTENTS
Chapter 1 introduces the fundamental features of bond, the type of issuers, and risk faced by
investors in fixed-income securities. Chapters 2–6 set forth the basic analytical framework
necessary to understand the pricing of bonds and their investment characteristics. The theory and
history of interest rates is also covered. Chapter 7 presents Treasury securities, Treasury
derivative securities, and federal agency securities. Chapters 8–10 provides details on the
investment characteristics and special features of U.S. corporate debt, municipal securities, and
non-U.S. bonds. Chapters 11–14 focus on residential mortgage-backed securities. Chapter 15
covers commercial mortgage loans and commercial mortgage-backed securities. Chapter 16
looks at asset-backed securities and Chapter 17 introduces pooled investment vehicles for fixed-
income investors. Chapter 18 covers the liquidity and trading of credit/spread products, while
Chapter 19 explains how to analyze bonds with embedded options. Chapter 20 analyzes
residential mortgage–backed securities, while Chapter 21 covers convertible bonds. Chapter 21
discusses measuring the credit spread exposures of corporate bonds. Chapter 22 analyzes the
corporate bond credit analysis and Chapter 23 provides the basics of credit risk modeling.
Chapters 24–26 covers bond portfolios in regards to its strategies, construction and management.
Chapter 27 investigates liability-driven investing for defined benefit pension plans. Chapter 28
examines bond performance measurement and evaluation. Chapters 29–30 covers interest-rate
futures contracts and interest-rate options. Chapter 31 examines interest-rate swaps, caps, and
floors while Chapter 32 investigates credit derivatives.
CHAPTER 1
INTRODUCTION
CHAPTER SUMMARY
This introductory chapter will focus on the fundamental features of bond, the type of issuers, and
risk faced by investors in fixed-income securities. A bond is a debt instrument requiring the
issuer to repay to the lender the amount borrowed plus interest over a specified period of time.
A typical (“plain vanilla”) bond issued in the United States specifies (1) a fixed date when the
amount borrowed (the principal) is due, and (2) the contractual amount of interest, which
typically is paid every six months. The date on which the principal is required to be repaid is
called the maturity date. Assuming that the issuer does not default or redeem the issue prior to
the maturity date, an investor holding this bond until the maturity date is assured of a known cash
flow pattern. Since the early 1980s a wide range of bond structures has been introduced into the
bond market.
SECTORS OF THE U.S. BOND MARKET
The U.S. bond market is divided into six sectors: U.S. Treasury, agency, municipal, corporate,
asset-backed securities, and mortgage. Bond investors consider these sectors when deciding on
their investment strategies.
© 2021 Massachusetts Institute of Technology 2
, The Treasury Sector
The Treasury sector includes securities issued by the U.S. government. These securities include
Treasury bills, notes, and bonds. This sector plays a key role in the valuation of securities and the
determination of interest rates throughout the world.
The Agency Sector
The agency sector includes securities issued by federally related institutions and government-
sponsored enterprises. The securities issued are not backed by any collateral and are referred to
as agency debenture securities.
The Municipal Sector
The municipal sector is where state and local governments and their authorities raise funds. This
sector is divided into two subsectors based on how the interest received by investors is taxed at
the federal income tax level: the tax-exempt and taxable sectors. The municipal bond market
includes two types of structures: tax-backed and revenue bonds.
The Corporate Sector
The corporate sector includes (i) securities issued by U.S. corporations and (ii) securities issued
in the United States by foreign corporations. Issuers in the corporate sector issue bonds, medium-
term notes, structured notes, and commercial paper. The corporate sector is divided into the
investment grade and noninvestment grade sectors.
The Asset-Backed Securities Sector
In the asset-backed securities sector, a corporate issuer pools loans or receivables and uses the
pool of assets as collateral for the issuance of a security. Captive finance companies (subsidiaries
of operating companies that provide funding for loans to customers of the parent company) are
typically issuers of asset-backed securities.
The Mortgage Sector
The mortgage sector is the sector where securities are backed by mortgage loans. The mortgage
sector is divided into the residential mortgage sector and the commercial mortgage sector. The
residential mortgage sector includes loans for one- to four-family homes. The commercial
mortgage sector covers commercial loans for income-producing property.
Bond Investors
Bond investors (including retail investors and institutional investors) have an opportunity to
invest in a pooled investment vehicle in lieu of constructing their own portfolio to obtain
exposure to the broad bond market and/or specific sectors of the bond market. For retail
investors, the benefits of investing in pooled funds are improved means for diversification,
liquidity, and professional management.
© 2021 Massachusetts Institute of Technology 3
