Maturity Structure of Yield Volatilities
Bond managers must quantify interest rate volatilities for bonds with embedded options because their values depend on the level of interest rate volatilities. Additionally, mitigating the effect of interest rate volatilities on a bond’s price volatility is part of risk…
Measuring Bond Exposure
Shaping risk is the sensitivity of a bond’s price to changes in the shape of the yield curve. An active bond investor trades based on the predicted shape of the yield curve. Yield curve risk is the bond portfolio exposure…
Developing Interest Rate Views Using Macroeconomic Variables
Key economic factors and market events influence interest rate dynamics such as the curvature, level, and steepness of the yield curve and changes in spot versus forward rates. Fixed-income traders use implied forward rates as market-neutral reference points. Active fixed…
Traditional Theories of the Term Structure of Interest Rates
The term structure is a relationship between interest rates and maturities of similar quality bonds. A yield curve is a graphical representation of the term structure of interest rates. The following theories explain the term structure of interest rates and…
Short Term Interest Rate Spreads
Market participants often use short-term interest rate spreads to evaluate liquidity and credit risk. A good example is the TED spread, which is a key indicator of perceived liquidity and credit risk. TED is formed from an abbreviation US T-bill…
Swap Spread
The swap spread is obtained by taking the difference between a swap’s fixed leg rate and the yield on a recently issued government bond (“on the run issue”) with the same maturity. Swap spreads can be used to value bonds….
Swap Rate Curve
An interest rate swap is a contract to exchange interest rate payments in the future between two parties over a specified period. Vanilla interest rate swaps (most commonly traded and most liquid) are contracts to exchange a fixed interest rate…
Riding the Yield Curve
Riding the yield curve (rolling down the yield curve) is an active trading strategy where a bond trader buys bonds with a maturity longer than their investment horizon. In an upward sloping curve, bonds with longer maturities earn higher yields…
Assumptions Relating to the Evolution of Spot Rates
Recall from the first learning objective of this reading that the forward rate lies above the spot rate for an upward sloping spot curve. On the other hand, the forward rate in a downward sloping spot curve lies below the…
Bootstrapping Spot Rates
Bootstrapping spot rates is a forward substitution method that allows investors to determine zero-coupon rates using the par yield curve. The par curve shows the yields to maturity on government bonds with coupon payments, priced at par, over a range…
