This question relates to unexpected interest rate effect and the answer states that a positive unexpected interest rate effect is consistent with unexpected falling yields or a favourable twist in the yield curve resulting in rising prices over the time period. What does this mean?? Can anyone explain??
Expected rates relies on forward curve. Unexpected relies on what happens during the measurement period. Forward curve implied rates of return of 4.2% and returns were 5.2% because rates moved down x(duration) means there was unexpected 1.0%.
Sorry I am confused here, correct me if I am wrong. Based on your explanation, would it be correct to say that unexpected interest rate effect is a form of return measure and thus when interest rates (or yields for that matter) move down, the return goes up just as like how a bond’s value increases when rates fall?
Exactly. The idea being that your portfolio should not be punished because rates moved up, consequently the analysis should not reward you for rates moving down. The unexpected helps to show how you performed on a duration measure compared to the index. If rates moved up 25bps for an unexpected move of 1% the index will have no duration contribution. If your portfolio had a duration contribution of 25bps that would count against the 1% move of the index. That is why the rates have to be split out compared to aggregated as actual performance. Forward curve is expected, unexpected is total return portion.
Got it. Thanks!!