Expert: Doug Ingram - 5/26/2003

Question
Hello Doug,
I heard of Fixed Income and I heard of
derivatives. But now heard the term Fixed Income
Derivatives.
What is that exactly?
Is there a link or place in the internet I can
read more about it?
Can you give me an example of such investment
model?

Thanks a lot,
Mike.  

Answer
Simply enough, a derivative is something that is derived from something else.  However, some financial derivatives are quite complex.

The simplest form is "stripping" coupons from a bond to create the strips (interest only) and a zero coupon bond (principal only).

More complex structures involve taking similar individual mortgages and creating a "pool" so investors can buy large blocks.  (that seasons their prepayment risk)

CMOs (collateralized mortgage obligations) are created by carving these pools of MBS (mortgage backed securities) into short pieces and structured cash flow securities.  Brokers carve MBS into many types of cash flows including floating and inverse floating rate bonds from fixed rate collateral.  

Advanced derivatives include swaps and swaptions.  Large banks may wish to offset fixed of floating rate risk with other firms that need the reverse coverage.

Search the internet under CMO, interest rate swaps, etc.