I know it’s in the formula for futures and adjusting duration, and that for most cases, it’s = 1. But what are the real world conditions that cause yield beta to be different than 1.
Volatility of the bond being hedged is higher/lower than volatility of the future contract.
yield beta is a regression coefficient (b) in the equation where the price change of the bond (bond portfolio) you are hedhing is dependent variable and price change of the cheapest-to-deliver (CTD) bond is independent variable. It essential measures the sensitivity between your bond and CTD. If your bond is substantially different with the futures contact you are using to hedge it (futures contract will use the suitable CTD), then yield beta will be different from 1.
So if there is substantial amounts of credit risk or embedded options in the portfolio and the futures hedge is just with treasuries, this would suggest paying attention to yield beta. You think they will make us figure out yield beta on the exam or will they just tell us what it is if they expect us to use it?
Ok yield beta I have down but what about conversion factor? I know how it is used but what exactly does it measure?
bchadwick Wrote: ------------------------------------------------------- > So if there is substantial amounts of credit risk > or embedded options in the portfolio and the > futures hedge is just with treasuries, this would > suggest paying attention to yield beta. > > You think they will make us figure out yield beta > on the exam or will they just tell us what it is > if they expect us to use it? Yield beta, is similar to stock beta, except instead of returns of stock Vs benchmark you use yields of bonds Vs yields of future ( your benchmark). It has nothing to do with credit risk or callability, it’s a measure of relative volatility.
Ah ok. So what causes the volatility to be different? Just different supply and demand dynamics for specific issues? With equity beta, you have business operational risk and financial risk caused by leverage. I think the analogue to business risk for stocks would be credit risk for bonds. Don’t think there is an equivalent analogue to financial risk, except perhaps seniority in the debt structure, which is an aspect of credit risk. By the way, this is helping me a lot, thanks!
its extremelly unlikely we’ll have to compute yield bete, it will certainly be given (if its even mentioned) and we need to understand what it is and when/how to use it conversion factor is the relationship between futures contract you are using to hedge and CTD underlying that contract; conversion factor = dollar duration of CTD / dollar duration of futures contract
The hedge used for futures is usually a treasury bond (there are no corp bond futures) so when you try and hedge a corp bond it’s yield is different then the treasury futures contract thus the yield beta.
You’re way out of my league now … I have no idea why the volatility would be different, good question to go over this summer
the two ways I’d see we have to compute it would be as follows: Domestic duration = yield beta * Foreign duration foreign change in interest rates = yield Beta * domestic change in interest rates
Ok so the yield beta is the difference between the futures contract (is this the CTD or the future hedge?) and asset your are trying hedge while the conversion factor is the difference between future you are using and CTD hedge instrument?
yield beta is the difference betweeen your bond and CTD conversion factor is the difference underlying futures and CTD
perfect, makes sense thanks.
mo34 Wrote: ------------------------------------------------------- > You’re way out of my league now … I have no idea > why the volatility would be different, good > question to go over this summer No prob, mo, just the volatility observation is a big help here; you’re right, best to catch up on that over the summer. – As for conversion factors, my understanding is that treasury futures can be satisfied by delivering any treasury with the correct par value and far enough away maturity, so the CTD bond may not exactly match the hypothetical bond that the future represents. The conversion factor is an adjustment to the value of the future to compensate for this difference. I’m not sure exactly how people know what the CTD is, unless the clearing house just tells you from their stock of stuff that they use.
I remember in the sample they had a question on this - distinguish between yield beta and conversion factor. Another question said, conversion factor is provided by the clearing house.