Loading....
Coupon Accepted Successfully!

 

Weakness of Single Factor Approach

 

  • Single factor approach assumes that all the future rate changes are driven by single factor
  • The same change in interest rate is assumed for the entire yield curve
  • In practice, change in short term interest rate might be different from the change in long term interest rate
  • Same hedging instrument cannot be used for hedging the change in short term interest rate and long term interest rate

Key Rate Exposures

 

  • Key Rates are the rates selected at key point on the yield curve. These are usually 2,5,10 and 30 year rates
  • Key rate exposures hedge risk by using rates from a small number of available liquid bonds
  • Partial ‘01 is used to measure the risk of the bond or swap portfolio in terms of liquid money markets and swap instruments
  • Forward ’01 is used to measure the risk of the bond or swap portfolio in terms of shifts in the forward rates

Key Rate Shift

 

  • Key Rate Shift technique is a approach to nonparallel shift in the yield curve
  • This technique allows to determine changes in all the rates due to the changes in key rates
  • Choice has to be made as to which key rates shifts and how the key rate movement relate to prior or subsequent maturity key rates

Key Rate ‘01 and Key Rate Durations

 

  • Key Rate ‘01 measures the dollar change in the value of the bond for every basis point shift in the key rate
    • Key Rate ‘01 = (-1/10,000) * (Change in Bond Value/0.01%)
  • Key rate duration provides the approximate percentage change in the value of the bond
    • Key Rate Duration = (-1/BV) * (Change in Bond Value/Change in Key rate)





Test Your Skills Now!
Take a Quiz now
Reviewer Name