Efficient Frontier

The efficient frontier was first defined by Harry Markowitz in his groundbreaking (1952) paper that launched portfolio theory. That theory considers a universe of risky investments and explores what might be an optimal portfolio based upon those possible investments. Consider an interval of time. It starts today. It can be any length, but one-year is typically assumed. Today’s […]

Callable Bond

A callable bond (or redeemable bond) is a bond whose indenture includes one or more call provisions providing for the early retirement (“call” or “redemption”) of the bond. Call provisions may provide for optional redemption, extraordinary redemption or sinking fund redemption. When included in a bond’s indenture, extraordinary and sinking fund redemption are “boiler plate” provisions that usually afford the issuer little opportunity to benefit at investors’ expense. Form […]

Asset-Liability Management

Asset-liability management (ALM) is a term whose meaning has evolved. It is used in slightly different ways in different contexts. Asset-liability management was pioneered by financial institutions, but corporations now also apply asset-liability management techniques. This article describes asset-liability management as a general concept, starting with more traditional usage. Motivation Traditionally, banks and insurance companies […]

Bankers Acceptance

A bankers acceptance (BA) is a money market instrument: a short-term discount instrument that usually arises in the course of international trade. Before we explain BAs, let’s introduce some more basic concepts. A draft is a legally binding order by one party (the drawer) to a second party (the drawee) to make payment to a third party (the payee). A simple example […]

Barings Brothers

Barings Debacle

The collapse of Britain’s Barings Bank in February 1995 is a quintessential tale of financial risk management gone wrong. The failure was unexpected. Over a course of days, the bank went from apparent strength to bankruptcy. Barings was Britain’s oldest merchant bank. It had financed the Napoleonic wars, the Louisiana purchase, and the Erie Canal. Barings was the Queen’s bank. […]

Bond Accrued Interest

In fixed income markets, professionals speak of a bond’s clean price or dirty price. These are two quoting conventions that differ in whether or not they include accrued interest in a bond’s quoted price. Exhibit 1 indicates the evolution of the market value of a 3% nominal yield 20-year bond during its first four years. In the evolution of the market […]

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