Fixed Income: Term Structure and Volatility of Interest Rates

Question 1

Yield Curve Shapes (4)

Answer 1

Normal: Positive slope

Flat: Horizontal

Inverted: Negative slope

Humped: Positive slope then negative

Question 2

Yield Curve Shifts (3)

Answer 2

1. Parallel: All maturies move by same bps
2. Twist: change in YC slope
3. Butterfly: + shift YC becomes less humped / - shift YC becomes more humped

Question 3

Expectation Theories: Term Structure of Interest Rates

Answer 3

1. Pure expectations: Geometric mean of short term yields
2. Liquidity preference: Long bond holders require higher premium
3. Preferred habitat: YC is determined by expectations that can be different for different maturities

Question 4

Annualizing the Standard Deviation: Fixed income

Answer 4

ASd = Daily Sd X √# of days in year