YCM 2001 - Yield Curve Theories

YCM 2001 - Yield Curve Theories - Theories of the Yield...

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1 Theories of the Yield Curve Copyright © 1996-2006 Investment Analytics
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 2 The Yield Curve ± What is the yield curve? ± How is the curve constructed? ± Why is the yield curve shaped the way it is? ± Why does its shape change? ± How can a trader profit from this?
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 3 ± Zero-Coupon Bonds, Face Value $1,000: ± Term Price Discount YTM 1 925.93 1/(1+y 1 ) 8.000% 2 841.75 1/(1+y 2 ) 2 8.995% 3 758.33 1/(1+y 3 ) 3 9.660% 4 683.18 1/(1+y 4 ) 4 9.993% ± Spot Yield (Zero Coupon Yield) ± y 1 is called the one year spot rate ± y 2 is called the two year spot rate The Yield Curve
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 4 Years to Maturity 8% Spot Rate 14 Yield Curve Example
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 5 ± In practice we have coupon bonds, not just zeros ± Term Price Discount YTM 1 925.93 Z 1/(1+y 1 ) 8.000% 2 841.75 Z 1/(1+y 2 ) 2 8.995% 3 952.40 C ± Bond in year 3 is a coupon bond ± Pays 8% coupon ($80 per year) ± How do we proceed? Building a Yield Curve
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 6 ± Method: split into coupon and principal payments and treat each as a zero ± Then solve equation: ± 952.40 = $80/(1+y 1 ) + $80/(1+y 2 ) 2 + $1080/(1+y 3 ) 3 ± y 1 & y 2 are known ± y 3 = 10.020% 12 3 $80 $80 $1,080 Bootstrapping
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 7 Example: US Treasury Yield Curve YIELD vs. MATURITY 15-Feb-15 15-Aug-15 15-Nov-15 15-May-16 15-Nov-16 15-Feb-16 15-May-17 7.40% 7.41% 7.42% 7.43% 7.44% 7.45% 7.46% 7.47% 7.48% Dec-14 Jul-15 Jan-16 Aug-16 Mar-17 Sep-17
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 8 Yield Curve Analysis ± Fairly normal yield curve ± Yield on the 9 1/4 of Feb ‘16 looks to be a basis point too high ± 2.4bp pickup on the 8 /4% of May ‘17 indicates value in this sector ± Clear relationship between yield and tenor ± What about relationship between yield and risk? ± Use duration as a proxy for risk ± Plot yield vs. duration ± Makes relative values more distinct
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 9 Yield vs. Duration YIELD vs. DURATION Nov 16 May 16 May 17 Feb 16 Nov 15 Aug 15 Feb 15 7.42% 7.43% 7.43% 7.44% 7.44% 7.45% 7.45% 7.46% 7.46% 7.47% 7.47% 7.48% 9.20 9.40 9.60 9.80 10.00 10.20 10.40
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Copyright © 1996-2006 Investment Analytics Yield Curve Theories Slide: 10 Yield Enhancement Swap ± Because it has higher coupon, the 8 3/4 of May ’17 has lower duration than the 7 1/4 of May ’16 or the 7 1/2 or Nov ’16.
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This document was uploaded on 11/04/2011 for the course ECON 421 at CUNY York.

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YCM 2001 - Yield Curve Theories - Theories of the Yield...

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