I could sense a peculiar feeling developing inside me while attending the Level II class. It was the same auditorium with similar arrangements but I was sitting on a different seat. Plenty of identical faces were present in the class with a few ones missing and several unrecognized. A new motivation was required to grasp the concepts of Level II as it seemed quite different from what we had studied in Level I.
The major difference which I sensed was the in-depth understanding required of the topics. It started off with Fixed Income, Study Session 14, Reading 50 - Valuing bonds with embedded options. I could recall the first class in Level I which was different in a sense that the terminologies discussed were alien to me. The good thing was whatever was being discussed let it be the key terms, jargon and concepts, it had started to make sense. It was an interesting element as retaining things considering them facts without knowing their reason for existence was the most difficult task for me.
The first question which troubled me was the relation of Volatility and Option Adjusted Spread for callable bonds. On the first day it was discussed in the class but I was able to figure out the answer after giving a complete reading of the chapter. As with the case of callable bonds, an increase in volatility increases the value of the call option and the option adjusted spread is calculated by subtracting option value from zero volatility spread. Understanding this relation made me figure out the logic behind a line written in text book that when the volatility increases the OAS decreases for callable bonds.
Using the interest rate tree and applying the concept of backwardation was another interesting topic which was covered during the first week. In fact it got even more attractive when it was used in valuing bonds with embedded options and floaters. Analysis of convertible bond was another important area which was covered in the first week and it got more valuable when we were told that Warren Buffet, an investment tycoon, purchased the convertible bonds issued by the Bank of America, which was in grave trouble those days. Securing the downside potential till the straight value, which in fact is a moving floor, of the bonds and having the chance of converting them into stocks when they outperform the fixed income securities, was an appealing aspect.
Towards the end of the week we covered the general principles of credit analysis. As I mentioned earlier, there is so much to learn and associate with the ‘real world’ in Level II that often it is hard to believe! The rating agencies which are considered experts and their opinions are disseminated over Bloomberg and Business week, we practically understood their methodology of rating other companies. Moody’s Investor Service, S&P Corporation, and Fitch ratings were the ones we discussed. The story didn’t stop on these companies in fact it started from them. Learning the ability to do credit analysis was the most interesting and appealing part of Reading 48. It equipped us with the skills required to do credit analysis by first figuring out questions through ratios and then answering them through cash flow, collateral and other investigations.
On the whole the first week was amazing in terms of learning and provided a deep ‘peep’ into the magical world of finance. Way back when I was in school I used to study a book named ‘How the Universe works?’ The first week reminded me off with my deep interest towards knowing things. Life may sometime in the future provide me with an opportunity to understand how the universe works but my joy of understanding how the finance universe works can’t be explained in words… For those who want to explore the different dimensions and levers of this magical world of finance, must take a bold step and become a part of this course.