On page 304 of the fixed income curriculum (and page 198 of Schweser) in step 3, why are we constructing a binomial tree on the “yield curve”? Why yield curve? I guess I’m totally lost, but I thought we built the tree using the one-year T-bill. Thanks.
um, when we are trying to find effectie duration, we gotta shock the curve dont we? we shock it once, we get a new curve, so we construct a new tree, we then colaberate the tree with OAS. we shock it again, opposite direction, we get a new curve, and a new tree, then we again colaberate the tree with OAS. I think this is what you are asking right?
We do not build tree using one year T-Bill, there is a lot more to it, many bills, or even other instruments, if you want read up on that… But I think I get what is confusing you… Let me see if this statement helps “Shocking up the yeild curve by X percent is the same thing as moving each of the SPOT rates X percent. Remember the yeild curve is a complex avg of the SPOT rates.”
Schweser practice exam 3, question 5, page 126-7: Step 2 (of 5): Correct answer is “Impose an upward parallel shift in the on-the-run Treasury yield curve of 100 bps.” Incorrect answer is “Add 100 basis points to each of the 1-year rates in the interest rate tree to derive a modified tree.” Why is the incorrect answer incorrect? Aren’t we adjusting the 1 year rates in the tree?