Yield Curve Strategies

Question 1

• On-the-run
• Off-the-run

Answer 1

• 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

Question 2

Buttefly spread

Answer 2

= −(Short-term yield) + (2 × Medium-term yield) − Long-term yield

Question 3

Active strategies under assumption of a stable yield curve

Answer 3

• Buy and hold
• Roll down/ride the yield curve
• Sell convexity
• The carry trade

Question 4

Active strategies for yield curve movement of level, slope, and curvature

Answer 4

• Duration management
• Buy convexity
• Bullet and barbell structures

Question 5

3 basic ways to implement an intra-market carry trade

Answer 5

• 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

Question 6

3 basic ways to implement an inter-market carry trade

Answer 6

• 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)

Question 7

Inter-market carry trades without currency risk

Answer 7

• 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.

Question 8

Combining Bond, Repo, and Currency Forward Positions

Answer 8

• The investor buys the bond @P_B
• The investor then sells the bond to the Repo counterparty
• The investor buys back the bond @P_B (1 + r_H)
• The investor pays X_LH P_B (1 + r_L) to the FX Fwd dealer and receives P_B (1 + r_H)
• X_LH is the initial spot exchange rate (expressed as lower interest rate currency per unit of the higher interest rate currency)

Question 9

Number of contracts required to reduce/increase the PVBP of the portfolio

Answer 9

= Required additional PVBP / PVBP of the futures contract

Question 10

Additional market value of bonds to be purchased using leverage to reduce/increase the PVBP of the portfolio

Answer 10

= Required additional PVBP / Duration of bonds to be purchased and financed * 10,000

Question 11

Effective portfolio duration when using leverage

Answer 11

Notional portfolio value / Portfolio equity × Duration

Question 12

Bond convexity relation to yield

Answer 12

A bond with higher convexity has a lower yield than a bond without higher convexity

Question 13

Protection against a steepening yield curve

Answer 13

Offered by bullet structure which can avoid maturities that are likely to be negatively impacted

Question 14

Environment in which to sell convexity

Answer 14

When interest rates are projected to remain stable

Question 15

Total forward return formula

Answer 15

Question 16

Effective convexity

Answer 16

Question 17

The price value of a basis point (PVBP) (also called dollar value/DV01)

Answer 17

• = 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

Question 18

Money duration

Answer 18

= market value * modified duration / 100

Question 19

Key rate duration predicted change in the value of a portfolio

Answer 19

• = portfolio par amount * partial PVBP * (-Δcurve)
• (-Δcurve) = (curve shift in bps)/100

Question 20

Modified duration predicted percentage change in the value of a bond

Answer 20

% P change ≈ –D × ΔY (in percentage points)  

Question 21

Butterfly bond portfolio

Answer 21

Simultaneously long/short a barbell and a bullet portfolio

Question 22

Butterfly bond portfolio common structures

Answer 22

• Duration-neutral weighting
• 50/50 weighting
• Regression weighting

Question 23

Butterfly and condor structures visual depiction

Answer 23

Question 24

Relative Performance of Bullets and Barbells under Different Yield Curve Scenarios

Answer 24

Question 25

Yield curve moves from most to least important

• Yield curve shift
• Yield curve twist
• Yield curve butterfly

Answer 25

• 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)

Question 26

Methods to sell convexity

Answer 26

• 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

Question 27

The cost of hedging a bond into a particular currency

Answer 27

= 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