Term
| What is bootstrapping used for? |
|
Definition
| for computing spot (or zero) rates from coupon bonds |
|
|
Term
| What interest rates play a key role in interest rate derivatives? |
|
Definition
- Treasury rates
- Libor
- Repo rates - the implied rate on a repurchase agreement |
|
|
Term
| What is an inverse floater (aka reverse floater)? |
|
Definition
it's a debt instrument whose coupon payments fluctuate with the reference rate (eg, Libor).
The inverse floaters coupon will increase when LIBOR decreases and vice versa |
|
|
Term
| Future value if compounded discreate compounding, i.e. compounded m times a year for n years: |
|
Definition
|
|
Term
| Future value if continuously compounded |
|
Definition
|
|
Term
| How do you calculate the continuously compounding rate from the discrete compound rate? |
|
Definition
|
|
Term
| if the 1 year rate is 2.136% and the 2 year rate is 2.915%, what is the 1 year forward rate one year from now? |
|
Definition
| RForward = R2 + [(R2 - R1) * (T1 / (T2 - T1)] |
|
|
Term
FRA payoff problem...
investor entered into an FRA where he has contracted to pay a fixed rate of 3% on 1million based on the quarterly rate in 3 months. Rates are compounded quarterly. Compute the payoff of the FRA if the quarterly rate is 1% in 3 months. |
|
Definition
| 1,000,000 (.01 - .03) (.25) = -5,000 |
|
|
Term
| What is the duration of a bond? |
|
Definition
the average time until the cash flows on the bond are received. For a coupon bond duration must be shorter than maturity. Give the formula for duration using continuously compounded discounting of the cash flows:
Duration tells you what the approximate change in a bond's prrice B, for a parallel shift in the yield curve
change in B / B = duration * change in yield |
|
|
Term
What does convexity do (account for)
formula for convexity effect: |
|
Definition
the amount of error in teh estimated price change based on duration. It converts the straight estimated line into a curve line that more accurately resembles the actual (convex) price line.
convexity effect = 0.5 * convexity * change yield2 |
|
|
Term
given a change in yield how do you work out the percentage bond price change?
Estimate the effect of a 100 bp increase and decrease on a 10 year 5% option free bond trading at par. Bond has a duration of 7 and a convexity of 90. |
|
Definition
% bond price change = duration effect + convexity effect
= -duration * change yield + 0.5 * convexity * (change yield)2 |
|
|
