Yield Curve Strategies Flashcards
- On-the-run
- Off-the-run
- On-the-run Treasuries are the most recently issued U.S. Treasury bonds or notes of a particular maturity
- Off-the-run Treasuries are Treasury securities that have been issued before the most recent issue and are still outstanding
Buttefly spread
= −(Short-term yield) + (2 × Medium-term yield) − Long-term yield
Active strategies under assumption of a stable yield curve
- Buy and hold
- Roll down/ride the yield curve
- Sell convexity
- The carry trade
Active strategies for yield curve movement of level, slope, and curvature
- Duration management
- Buy convexity
- Bullet and barbell structures
3 basic ways to implement an intra-market carry trade
- Buy a bond and finance it in the repo market
- Received fixed and pay floating on an interest rate swap
- Take a long position in a bond (or note) futures contract
3 basic ways to implement an inter-market carry trade
- Borrow from a bank in the lower rate currency, convert the proceeds to the higher rate currency, and invest in a bond denominated in that currency.
- Enter into a currency swap, receiving payments in the higher rate currency and making payments in the lower rate currency.
- Borrow in the higher rate currency, invest the proceeds in an instrument denominated in that currency, and convert the financing position to the lower rate currency via the FX forward market (buy the higher rate currency forward versus the lower rate currency)
Inter-market carry trades without currency risk
- Receive fixed/pay floating in the steeper market and pay fixed/receive floating in the flatter market
- Take a long position in bond (or note) futures in the steeper market and a short futures position in the flatter market.
Combining Bond, Repo, and Currency Forward Positions
- The investor buys the bond @PB
- The investor then sells the bond to the Repo counterparty
- The investor buys back the bond @PB (1 + rH)
- The investor pays XLH PB (1 + rL) to the FX Fwd dealer and receives PB (1 + rH)
- XLH is the initial spot exchange rate (expressed as lower interest rate currency per unit of the higher interest rate currency)
Number of contracts required to reduce/increase the PVBP of the portfolio
= Required additional PVBP / PVBP of the futures contract
Additional market value of bonds to be purchased using leverage to reduce/increase the PVBP of the portfolio
= Required additional PVBP / Duration of bonds to be purchased and financed * 10,000
Effective portfolio duration when using leverage
Notional portfolio value / Portfolio equity × Duration
Bond convexity relation to yield
A bond with higher convexity has a lower yield than a bond without higher convexity
Protection against a steepening yield curve
Offered by bullet structure which can avoid maturities that are likely to be negatively impacted
Environment in which to sell convexity
When interest rates are projected to remain stable
Total forward return formula
Effective convexity
The price value of a basis point (PVBP) (also called dollar value/DV01)
- = market value * modified duration / 10,000
- Is an estimate of the change in a bond’s price given a 1 bp change in yield to maturity
Money duration
= market value * modified duration / 100
Key rate duration predicted change in the value of a portfolio
- = portfolio par amount * partial PVBP * (-Δcurve)
- (-Δcurve) = (curve shift in bps)/100
Modified duration predicted percentage change in the value of a bond
% P change ≈ –D × ΔY (in percentage points)
Butterfly bond portfolio
Simultaneously long/short a barbell and a bullet portfolio
Butterfly bond portfolio common structures
- Duration-neutral weighting
- 50/50 weighting
- Regression weighting
Butterfly and condor structures visual depiction
Relative Performance of Bullets and Barbells under Different Yield Curve Scenarios
Yield curve moves from most to least important
- Yield curve shift
- Yield curve twist
- Yield curve butterfly
- Parallel or non-parallel level change in all yields
- Slope change (steepening/flattening - the ends of the curve move in opposite direction)
- Curvature change (the long and short ends of the curve move in the direction opposite to that of the intermediate maturities)
Methods to sell convexity
- Sell calls on bonds owned
- Sell puts on bonds one would be willing to own
- Buy securities with negative convexity, such as callable bonds or mortgage-backed securities
- Sell a payer swaption
The cost of hedging a bond into a particular currency
= the short-term rate for the currency into which the bond is hedged minus the short-term rate for the currency in which the bond is denominated
