Term Structure & Int Rate Volatility

Question 0

What are three ways yield curve can change and what drives these changes

Answer 0

Parallel shift - proportionate rate/maturity change
Non parallel shift - disproportionate rate/maturity change
Butterfly twist - change in “humped” nature

Question 1

What relationship does yield curve show

Answer 1

Interest rates and time to maturity

Ie term structure

Normal (up), flat, inverted (down)

Question 2

What are three term structure theories

Answer 2

Pure expectations
Liquidity preference
Preferred habitat

Question 3

What is pure expectations theory and implications

Answer 3

Forward rates are only a function of expected future spot rates

Upward yield curve = ^ short term rates
Flat yield curve = constant short term rates

Question 4

What is liquidity preference theory

Answer 4

Pure expectations plus liquidity premium for interest rate risk exposure which is positively related to maturity

Question 5

What is preferred habitat theory

Answer 5

Fwd rates = exp future spot plus premium

Premium is related to supply and demand for specific maturities

Question 6

What is key rate duration

Answer 6

Approx % change in bond value / 100 basis point change in key rate