CFAI Text Vol 6, P.169, 1st paragraph and 2008 AM Exam Q10B Expected I/R effect : The return from the implied forward rates. Unexpected I/R effect : The difference between the actual realized return and the market implied return from the forward rates. Can anyone explain clearly/tangible what do these 2 definitions actually mean ?
Expected I/R effect: Implied forward rates are calculated directly from the YC. For example if you have a 1 year rate and 2 year rate, you can calculate the 1 year rate 1 year from today. That’s the expected or “implied” fwd rate. Unexpected I/R effect: Now you have calculated the implied 1 year fwd rate 1 year from today. A year has passed, what is the 1 year rate? Is it different from what you have calculated a year ago? Is so, that’s the unexpected effect. I hope it was clear.
mik82, Thank you so much !