A completely updated edition of the guide to modern bond analysis. First published in , Inside the Yield Book revolutionized the fixed-income industry and. A completely updated edition of the guide to modern bondanalysis First published in , Inside the Yield Bookrevolutionized the fixed-income industry and. The third edition of Inside the Yield Book builds on the previous editions with valuable insights into duration targeting. The authors convey their mathematically .
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PRAISE FOR Inside the Yield Book The Classic That Created the Science of Bond Analysis BY SIDNEY HOMER AND MARTIN L. LEIBOWITZ, PH.D. “For active. READ PDF Inside the Yield Book: The Classic That Created the Science of Bond Analysis By Martin L. Leibowitz DOWNLOAD EBOOK PDF. First published in , Inside the Yield Book revolutionized the fixed-income industry and forever altered the way investors looked at bonds.
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Sidney Homer had joined Salomon in to set up a bond market research department. He had hired me a year later. My role eventually expanded to assuming overall research responsibilities. By the time Marty arrived, Sidney had already published his monumental book, A History of Interest Rates, followed by a number of papers on the behavior of interest rates from a portfolio management perspective.
However, Sidney and I concluded that the time was now ripe for a more quantitative approach to evaluating the opportunities and pitfalls in the bond market. With a doctorate in mathematics, Marty was well prepared to join with us in this new pursuit.
I should explain the title Inside the Yield Book. Market veterans will understand the title, but newcomers generally will not. Traders and investors would agree on the yield basis for a trade and then laboriously plow into these tables to determine the corresponding price.
There were two problems that became increasingly troublesome as the bond market began to experience enormous growth in the size and breadth of new issues. The first problem was that, with the increasing range of interest rates during the s and s, these volumes became thicker and thicker, resulting in an ever longer time required to find the interpolated price and then negotiate a given trade. Today, the computer has basically solved this problem. Sidney Homer had long been urging market participants to move toward a more total-return orientation that would be consistent with modern financial theory.
The insights and observations in Inside the Yield Book are as true today as they were then. In particular, the chapters on present value, interest on interest, and the different rates of return have often been cited as among the clearest exposition of these key concepts, which are fundamental to understanding the analysis of cash flows not only in the bond world but in any area of finance.
He became the head of an important division in research known as the Bond Portfolio Analysis Group. Marty attracted a number of highly competent quantitative analysts, many with Ph. Many of these analysts went on to achieve wide recognition on their own. Marty led the research effort by example.
Over the course of the years, there was an outpouring of writings. The range of subjects covered in these pages is truly breathtaking. In this capacity, he was able to put many of his investment ideas and theories into practice. Perhaps the most striking feature was the trays of half-eaten lunches, several days old, that could be stacked three and four high on the trading desks.
The traders always ate at their desks and rarely had time to clear away their uneaten sandwiches. As a freshly minted Ph. Sidney Homer was remarkable on many counts. In fact, when my wife, Sarah, and I were married in , it was Sidney who accompanied her down the aisle in lieu of her father who had passed away years earlier. Sidney was a man with a patrician presence. His parents were both musicians of the first rank. His father, also named Sidney Homer, was a composer of superb classical art songs, and his mother, Madame Louise Homer, was a renowned mezzo-soprano with a long career at the Metropolitan Opera, singing with the greats such as Enrico Caruso.
Alas, as is almost always the case with the arts, talent and funding follow separate paths: Sidney may have had an aristocratic upbringing, but his family was far from wealthy. So when Sidney fell in love and married at a very young age, he had to go to work. But quality shines through. Sidney became a highly skilled bond manager, spending the larger part of his career at Scudder, Stevens and Clark.
Along the way, his inquiring mind led him not just to participate in the bond market, but to study it deeply and write about his findings. He wrote several books that became classics in their day. It is now out of print but highly prized by those who have a copy. He managed to take a potentially tedious subject and make it into a fascinating story relating cyclical sweeps in interest rates to grand societal changes. The book has been through several editions, with the latest updated by Henry Kaufman and Richard Sylla, an eminent financial historian from New York University.
Its most thorough reader was undoubtedly the young Dr. One of the senior partners, Charles Simon, realized that for the firm to flourish, it needed to provide services beyond the best price to its customers.
He hit upon the idea of creating a bond market research department—the first on Wall Street— and he enticed Sidney to head it up. Back in those days, bond trading was an arcane backwater. He pulled me aside and dug out a file that contained about fifty handwritten pages of a never-finished book entitled The Mathematics of Bonds. He explained that this project was begun many years before, but it had foundered into filedom.
He had started the book by setting forth a number of principles that he and virtually every other bond market participant was sure were true. One of these principles was that longermaturity bonds have greater price volatility than shorter bonds. After years of letting his manuscript collect dust, he now wondered if I would take a look at it to see if my mathematical background could help untangle the paradox.
I must confess that, at that point, my knowledge of bonds was nonexistent. But I gamely took the pages home and worked up the relatively straightforward algebra that defined yield-to-maturity and related it to a bond price. When I presented my findings, he was duly appreciative and gracious, as he always was. However, at this point neither Sidney nor I was particularly excited by my explanations.
They might be illuminating, but neither of us saw how they could prove really useful. That surprised me.
At first, Sidney was not encouraging. His research department was very compact at that point, and he certainly did not have room for someone not steeped in the financial markets. But persistence pays off sometimes , and one day Sidney heard that two of his associates, Morris Offit and Harry Peterson, were looking for someone to develop computer-based analyses that could facilitate various trading activities.
One thing led to another and I eventually found myself manning the single, time-shared computer terminal on the trading floor at 60 Wall Street the one with the stacks of old lunch trays. This consisted of sitting next to various traders, plugging into their phone lines, and listening to their dialogues. Because trade talk is almost always highly compressed, clipped, super-fast, and replete with market jargon and other specialty words , this was an arduous learning experience.
Coincidentally, on my very first day, I was assigned to sit next to a young but clearly up-and-coming equity trader by the name of Mike Bloomberg. Work on the trading floor was hectic, but it gave me a great education about the financial markets and the transaction process.
The traders and salesmen were generally kind to me. They became even kinder when I was able to develop a package of computer programs that facilitated a number of trades. Also, with my little time-sharing terminal, I could determine the yield for any given price with great speed and accuracy.
Senior partners lined up in front of my terminal, desperate for the number that could confirm their latest trade. Needless to say, this boosted my standing on the floor, although it put me in a harrowing position in which any mistake could prove fatal. In the financial world, the gestation period can be very compressed. It was not many weeks before computer terminals and clunky special-purpose hand-held yield calculators sprouted up all over the trading floor.
The broad-based use of computers to replace the yield book tables did nothing to further the general understanding of what a bond yield was all about. In fact, the great facility of the computer may have been a step backward. Traders could punch in a few numbers and the desired yield value would pop up. There was no need to ponder what it all meant, or what would happen if you changed the coupon or the maturity.
At least the old yield book procedure required a table look-up and an interpolation that forced the trader to move a finger up and down the yield rows and across the maturity columns. So, in a sense, the advent of the computer capability actually reduced the need for an appreciation of what a yield really meant.
This may be a general problem of our computer age. The computer can be an effective facilitator in all sorts of areas, but its use on a rote basis also dulls the desire to seek a deeper understanding. At that time, most bond portfolios were long-term oriented, and our analytical models typically focused on the long-term benefits of holding one type of bond versus another.
In order to make fair comparisons, we had to assume that cash receipts were reinvested at a common set of hypothetical interest rates.
We soon began to notice that the return from a given bond investment depended critically on the assumption of a common reinvestment opportunity and on the choice of that reinvestment rate. This finding greatly surprised many of the bond veterans. From my earlier discussions with Sidney, I knew that this was not the case. Now the computer models validated the idea that reinvested rates played a critical role in the wealth buildup. A number of paths converged when I realized that 1 the reinvestment effect was theoretically important, 2 this effect was also practically important i.
This realization signaled opportunity, and I went to visit Sidney in his off-the-floor office oak-paneled, naturally. Sidney was very interested. A week later, while I was on vacation in Florida, Sidney tracked me down to tell me that he had been ruminating on my reinvestment results.
He said that we would be coauthors of the finished product.
It was viewed by many readers as an attack on the sanctity of the standard yield measure. There was considerable outrage among many of the crustier members of the bond community and there were a lot of crusty members!
Sidney received many indignant calls and letters from valued friends and even more valued customers. All of these communications were turned over to me, and Sidney charged me with the job of responding to—and convincing—each and every complainant. This hardly seemed like the ideal way to launch a fledging financial career. The good news was that as I methodically chewed through the correspondence that Sidney piled on my desk, I found myself coming into contact with the pillars of the bond community.
Sidney was steadfast in his support. Moreover, he put his prestige on the line by personally making appointments for us to visit the offices of the remaining recalcitrant customers.