Fixed Income Securities: Valuation, Risk, and Risk Management

CHAPTER 1

AN INTRODUCTION TO FIXED INCOME MARKETS

1.1   INTRODUCTION

In the past two decades, fixed income markets have experienced an impressive growth, both in market value and in complexity. In the old days, until the end of the 1980s, fixed income markets were dominated by government debt securities, such as United States government Treasury bills, notes, and bonds. These securities were also relatively simple, as the U.S. government mainly issued bonds paying a fixed amount of money semi-annually. Although other governments, such as those of the United Kingdom and Italy, also experimented with other types of debt securities whose semi-annual payments were not fixed, but rather linked to a floating index, for instance, the inflation rate, such markets were relatively small. Thus, the U.S. government debt market was the main reference for global fixed income markets.

Today, however, the U.S. government debt is no longer the dominant fixed income market, not so much because the U.S. debt shrank over the past two decades, but rather because other fixed income markets rose substantially relative to U.S. debt and became the main reference for fixed income pricing. Table 1.1 provides a snapshot of the sizes of fixed income markets as of December 2008. The first block of markets comprises the traditional fixed income markets, including U.S. government debt securities, municipal bonds, federal agency securities and the money market. The total size of these debt markets is around $15 ...