Fixed Income Flashcards
(51 cards)
riding the yield curve
when yld curve is UPWARD sloping, holding long-maturity bonds, earns an excess return as the bond “rolls down the yield curve)
swap rate curve
reflect credit risk of commercial banks rather than gov’t
swap market is not regulated by any gov’t
swap curve typically has yield quotes at many maturities
swap spread
swap rate - t-bill
z-spread
when added to each spot rate on the yld curve, makes the pv of a bond’s cf equal to the bond’s market price
appropriate spread measure for option-free corp. bonds, credit CDS, and ABS.
TED spread
3-month libor - 3-month T-bill rate
Libor-OIS spread
amount by which the LIBOR rate exceeds the overnight indexed swap rate.
it’s a useful measure of credit risk and provides an indication of the overall well-being of the banking system.
unbiased expectations theory
pure expectation
forward rates are an unbiased predictor of future spot rates
local expectations theory
preserves the risk-neutrality assumption only for short holding periods, whole over long periods, risk premiums should exist
This implies that over ST period, every bond should earn rf.
liquidity preference theory
investors demand a liquidity premium that is positively related to a bond’s maturity
segmented markets theory
shape of the yld curve is the result of the interactions of supply and demand for funds in diff. market segments
investors in one maturity segment of the market will not move into any other maturity segments.
preferred habitat theory
similar to segmented markets theory, but recognizes that market participants will deviate from their preferred maturity habitat if compensated adequately.
equilibrium term structure models
CIR
Assumes the economy has a natural long-run interest rate (b) that short-term rate converges to.
dr=a(b-r)dt+sigma sqr(r)dz
equilibrium term structure models - Vasicek model
assumes that interest rate volatility level is independent of the level of ST interest rates
constant volatility
dr = a(θ − r)dt + σdz
arbitrage models -Ho-Lee model
is calibrated by using market prices to find the time-dependent drift time that generates the current term structure.
dr(t) = theta dt + σdz
effective duration
sesitivity of a bond’s price to parallel shifts in the bmk yld curve
=BV(-change in yld) - BV(+ change in yld)
/ 2BV0*change in yld
key rate duration
measures bond price sensitivity to a change in a specific par rate, keeping everything else constant
sensitivity to parallel, steepness, and curvature movemtns
measures sensitivity to three distinct categories of changes in the shape of the benchmark yield curve.
binomial interest rate tree framework
lognormal random walk model with 2 equally likely outcomes
pathwise valuation
value of the bond is the avg of the values of the bond at each path
2^(n-1) possible paths
monte carlo forward-rate simulation
uses pathwise valuation and a large number of randomly generated simulated paths
used to value MBS
Value of Call option
=Vs-Vcallable
Value of Put option
=Vputable-Vs
OAS
the constant spread added to each forward rate in a bmk binomial interest rate tree, such that the sum of the pv of a credit risky bond’s cash flows equals its market price
=z-spread - option cost
one-sided duration
when interest rates rise versus when they fall
better at capturing interest rate sensitivity than regular effective durations
when option is at-or-near-the-money, callable/putable bonds will have lower/higher one-sided down-duration than one-sided up-duration
