The Term Structure and Interest Rate Dynamics Flashcards
Give two interpretations for the following forward rate:The two-year forward rate one year from now is 2%.
- 2% is the rate that will make an investor indifferent between buying a three-year zero-coupon bond or investing in a one-year zero-coupon bond and, when it matures, reinvesting in a zero-coupon bond that matures in two years.
- 2% is the rate that can be locked in today by buying a three-year zero-coupon bond rather than investing in a one-year zero-coupon bond and, when it matures, reinvesting in a zero-coupon bond that matures in two years.
How do I interpret this forward rate - F1,2
F(When, Where)
2 years rate one year from now
1year from now the 2 year rate
If one-period forward rates are decreasing with maturity, the yield curve is most likely
Decreasing
If one-period forward rates are decreasing with maturity, then the forward curve is downward sloping. This turn implies a downward-sloping yield curve where longer-term spot rates zB–A are less than shorter-term spot rates zA.
If interest rates rise, and the future spot rates are below the forward rates, what does it mean?
Bonds are undervalued
Elaborate Zakarias explenation for where demoninator and rot should go for f(2,3) when calculating forward rates
For f(2,3)
The denominator is to the power of 2
and the rooth is the 3rd root.
I rates rises, and the future spot prices are above the implied forward curve
Bonds are overvalued
Spot rises, but below the forward curve
Bonds are undervalued
We should buyer longer bonds than our Investment horizion
Spot rises, but above the forward curve
Bonds are overvalued
We should follow a maturity matching strategy
Swap rate
The rate on the fixed leg of a interest rate swap
Swap spread
The spread between the fixed rate payer of a swap (Swap rate) and the rate of a “on the run” government bond with the same maturity as the swap that pays coupons.
Swap Spread = Swap Rate - Govenment bond (on the run) that pays coupons.
Where are forward rates derived from?
Forward rates are derived from spot rates/spot curve of zero coupon bonds
Where are spot rates derived from?
Spor rates are derived from par rates using bootstraping
What is the G-Spread
Difference between credit risky bond rates - Spot rates
The difference between the yield on Treasury Bonds and the yield on corporate bonds of the same maturity
What is the I-Spread
The difference between credit-risky bonds and the Swap rate
Bear Flattener
Rates are going up more on the short end than the long end
Bear flattener refers to the convergence of interest rates along the yield curve as short term rates rise faster than long term rates and is seen as a harbinger of an economic contraction.
a situation of rising bond prices which causes the long-end to fall faster than the short-end. Bear steepeners and flatteners are caused by falling bond prices across the curve.
Bear Steepener
Rates on the short end rise less than on the long end.
Long term rates rise more than short term rates.
Rates on the long end rise more than on the short end.
Causes: Increase in long term inflation expectation with no action of central bank/monetary policy.
Bull flattener
Rates on the long end of the curve drops more on the long end than the short end.
Causes: QE pushes capital to higher riskier assets. Or a flight to quality.
Bull steepener
Rates on the short of the curve end decreases more than on the long end.
A bull steepener is a shift in the yield curve caused by falling interest rates—rising bond prices—hence the term “bull.”
The short-end of the yield curve (which is typically driven by the fed funds rate) falls faster than the long-end, steepening the yield curve.
