Week 2 - Interest rate risk Flashcards
Why is it harder to hedge non-linear products than linear ?
Nonlinear products are more difficult to hedge for 2 reasons:
- making a nonlinear portfolio delta neutral only protects against small price changes.
- they require dynamic hedging ie the hedge needs to be changed often.
If a portfolio has high Gamma…
..then the portfolios delta is highly sensitive to changes of the underling asset and frequent adjustments are needed to maintain it delta neutral.
A linear product has a gamma of …
0
What does duration measure?
Duration measures the sensitivity of percentage changes in the bond’s price to changes in its yield
In a zero-coupon bond the duration is equal to…
it’s time to maturity t.
Duration is essentially..
… a measure of how long the bondholder has to wait for cash flows.
A coupon-bearing bond lasting n years has a duration of … than n years, because the holder receives some of the cash payments prior to year n.
less
What is Dollar duration?
dollar duration relates actual changes in the bond’s price to its yield, is similar to the delta measure.
D$ = - dB/dy
Claim: Duration measures exposure to large changes in the yield.
FALSE:
small
What is convexity?
The convexity of a bond is defined as the change in duration when the yield changes (similar to Γ)
What is LIBOR?
The LIBOR rate is a short-term borrowing rate for AA-rated financial institutions
The LIBOR/swap term structure of interest rates has traditionally been used as …
… a proxy for the term structure of risk-free interest rates.
Claim: Gamma is smallest for options that are close to in the money
False!
Gamma is largest for options that are close to in the money
When making a portfolio gamma and Delta neutral you start by gamma, true or false?
True!
Then make Delta neutral by Buy or Sell D0 + wT*ΓT
When making the portfolio than neutral, you buy or sell… And when you make the portfolio, neutral you buy or sell…
Underlying asset
Option
