KIC000006 - duration vector Since we have many points on...

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Static or Z Spread Using the cash flow for a defaultable bond, we can add to the spot rate to get the price that matches the market. Adding a constant is comparable to the YTMspread. The constant number added to the spot fate that makes the discounted cash flows equal to the market price is the static spread. This is also known as the Zero Volatility (Z)spread since interest rates are deterministic. M + , (1 r, ss)' +-+- 2 2 Revisiting Sensitivity Duration is a nice summary measure of sensitivity, but has errors. We could measure sensitivity of price to static spread changes, holding spot rates constant. Or we could measure sensitivity of price to spot rates holding static. spread constant. We have to hold something constant! Since yield has the spread in it, duration is the simplest way to calculate sensitivity even though it has errors. KeyRate Durations Portfolios with No Default Risk We can come up with a bunch of duration measures for each point on the spot curve, holding other spot rates constant. Then we have what's known as a
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Unformatted text preview: duration vector Since we have many points on the spot curve, we should probably select some key rates. Ho (1992) focuses on 11 key spot rates: 3 month, lV, 2Y, 3Y, 5Y, 7Y, lOY, 15Y, 20Y, 25Y, 30Y. Use same method: P- p+ 2(Po)(Llr) 9 Spot Curves & Trees FIN 428 Prof. Hood Term Structure Models The term structure has expectations and risk premia built in, We can model the term structure mathematically with uncertainty or not. In some cases uncertainty is important, in others it is not. For pricing purposes, we can ignore uncertainty or combine the expectations and risk premia together. Methods:-Curve fitting with no uncertainty-Binomial trees (acids volatility)- Stochastic processes - many different forms Sources for Rates On the run Treasuries Off the run Treasuries (STRIPS & PSTRIPS 3 possible scenarios for N unknown spots:-Less than N prices-N prices- More than N Prices 1...
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This note was uploaded on 09/06/2011 for the course FIN 428 taught by Professor Hood during the Fall '11 term at Iowa State.

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KIC000006 - duration vector Since we have many points on...

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