Chapter3 - FIXED-INCOME SECURITIES Chapter 3 Term Structure...

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Chapter 3 Term Structure of Interest Rates: Empirical Properties and Classical Theories FIXED-INCOME SECURITIES
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Outline Types of TS Shapes of the TS Dynamics of the TS Stylized Facts Theories of the TS
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Types of Term Structures The term structure of interest rates is the series of interest rates ordered by term-to-maturity at a given time The nature of interest rate determines the nature of the term structure The term structure of yields to maturity The term structure of zero coupon rates The term structure of forward rates TS shapes Quasi-flat Increasing Decreasing Humped
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Quasi-Flat US YIELD CURVE AS ON 11/03/99 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 0 5 10 15 20 25 30 maturity par yield Quasi-Flat Quasi-Flat
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Increasing Increasing Increasing JAPAN YIELD CURVE AS ON 04/27/01 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 0 5 10 15 20 25 30 maturity par yield
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Decreasing Decreasing (or inverted) Decreasing (or inverted) UK YIELD CURVE AS ON 10/19/00 4.50% 5.00% 5.50% 6.00% 0 5 10 15 20 25 30 maturity par yield
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Humped (1) Humped (decreasing then increasing) Humped (decreasing then increasing) EURO YIELD CURVE AS ON 04/04/01 4.00% 4.50% 5.00% 5.50% 0 5 10 15 20 25 30 maturity par yield
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Humped (2) Humped (increasing then decreasing) Humped (increasing then decreasing) US YIELD CURVE AS ON 02/29/00 5.50% 6.00% 6.50% 7.00% 0 5 10 15 20 25 30 maturity par yield
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Dynamics of the Term Structure The term structure of interest rates changes in response to Wide economic shocks Market-specific events Example On 10/31/01, Treasury announces that there will not be any further issuance of 30 year bonds Price of existing 30 year bonds is pushed up (buying pressure) 30 year rate is pushed down
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Example – US YTM TS J-99 M-99 S-99 J-00 M-00 S-00 J-01 4 5 6 7 YTM maturity time US term structure of government YTM
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Stylized Facts (1) : Mean Reversion Mean reversion: high (low) values tend to be followed by low (high) values Example: 10 Y swap rate versus Dow Chemical 0 5 10 15 20 25 30 35 40 45 50 01/01/1990 01/01/1991 01/01/1992 01/01/1993 01/01/1994 01/01/1995 01/01/1996 01/01/1997 01/01/1998 01/01/1999 Dow Chemical en US $ Taux de swap 10 ans en %
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Stylized Facts (2) : Correlation Rates with different maturities are Positively correlated one another Not perfectly correlated though (more than one factor) Correlation decreases with difference in maturity Example: France (1995-2000) 1M 3M 6M 1Y 2Y 3Y 4Y 5Y 7Y 10Y 1M 1 3M 0.999 1 6M 0.908 0.914 1 1Y 0.546 0.539 0.672 1 2Y 0.235 0.224 0.31 0.88 1 3Y 0.246 0.239 0.384 0.808 0.929 1 4Y 0.209 0.202 0.337 0.742 0.881 0.981 1 5Y 0.163 0.154 0.255 0.7 0.859 0.936 1 7Y 0.107 0.097 0.182 0.617 0.792 0.867 0.927 0.97 1 0.073 0.063 0.134 0.549 0.735 0.811 0.871 0.917 0.966 1
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Stylized Facts (3) The evolution of the interest rate curve can be split into three standard movements Shift movements (changes in level), which account for 70 to 80% of observed movements on average A twist movement (changes in slope), which accounts for 15 to 30% of observed movements on average
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This note was uploaded on 04/07/2012 for the course ECONOMICS 101 taught by Professor Tillet during the Spring '12 term at Broward College.

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Chapter3 - FIXED-INCOME SECURITIES Chapter 3 Term Structure...

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