In Chapter 39 we valued default risk by modeling the firm’s assets, earnings, and cash. That is the “look inside the company” approach. Chapter 40 takes a completely different path. Instead of trying to understand why a company might default, just model default as a random external event. Roll a die. If you get a 1, the company defaults. Simple.
Welcome to Part Four of Wilmott’s book: Credit Risk. Up until now, every product we priced assumed that all cashflows are guaranteed. Coupons get paid. Bonds get redeemed. Nobody goes bankrupt. That was a comfortable world to live in, but it is not reality.
Emerging market bonds sound exotic. But they are actually a massive, growing slice of the global fixed income universe. We’re talking about $29.6 trillion in total EM fixed income as of 2020. And yet most investors either ignore them completely or treat them as a single homogenous bucket of “risky stuff.”
Book: Financial Markets and Institutions, 11th Edition Author: Jeff Madura Publisher: Cengage Learning, 2015 ISBN: 978-1-133-94788-2
Chapter 19 is where the rubber meets the road. You know what banks are (Chapter 17) and how they are regulated (Chapter 18). Now the question is: how do bank managers actually run these things day to day? The answer involves juggling several types of risk at once while trying to maximize shareholder value.
Book: Financial Markets and Institutions, 11th Edition Author: Jeff Madura Publisher: Cengage Learning, 2015 ISBN: 978-1-133-94788-2
Chapter 2 explained why the general level of interest rates changes. Chapter 3 answers a different question: why do different securities pay different yields at the same point in time? A Treasury bond and a corporate bond with the same maturity do not offer the same return. This chapter explains why.