Two Bond Hedge Assumptions

State the 4 assumptions required to construct a two-bond hedge (8 pts):

Model for prepayment is sound Assume good estimate for the up move and down move for the bonds used … …

Volatility assumptions of Montecarlo simulations are valid. Average price change is a good approximation for how prices will change

  • Considered most scenarios of yield curve shifts in modeling - Reasonably accurate prepayment model has been used - Reasonably accurate model has been used to derive the price sensitivities given a SMALL yield change - Using the average price change methodology is statistically and empirically sound

lxwqh, was that off the top of your head? or did you look it up?

I read about this a couple days ago / not sure all correct