Yield curve strategies

Does anyone understand the reasoning behind exhibit 2 in the eoc last item set for Q 23-32?

It says 1 deviation change and the effects. I am completely lost here!!! what is the 1 std move?

What are we trying to do here- what is the question asking?

Component C might be, say, Level. So over the last, say, 10 years, we have computed the average Level change per year and the standard deviation of annual Level changes. The table tells us that a 1_σ_ change in Level increases the 6-month yield by 3.6bp per week, it increases the 2-year yield by 8.1bp per week, and so on.

magician

“The table tells us that a 1_σ_ change in Level increases the 6-month yield by 3.6bp per week”

What is 1 Std. change in level?

Got me.

It’s whatever one standard deviation is over whatever measurement period they chose to collect and analyze data.

The point is that the absolute amount doesn’t matter.

What matters is that for Component A, 68% of the time (more or less), the change to the 6-month yield will lie between −6.0bp and +6.0bp per week, for Component B, 68% of the time (more or less), the change to the 6-month yield will lie between −5.3bp and +5.3bp, and for Component C, 68% of the time (more or less), the change to the 6-month yield will lie between −3.6bp and +3.6bp, and that positive changes in Components A and C produce positive changes in the 6-month yield while a positive change in Component B produces a negative change in the 6-month yield.

Hi magician,

Thanks for the explanation. I kind of understand positive 1 std. change is between 6 and -6 for 6 month maturity for component A.

But then how do you explain negative numbers?

For Component B, 68% of the time (more or less), the change to the 6-month yield will lie between −5.3bp and +5.3bp,Why is there a negative number here?

Thanks a lot I am really struggling to understand this table.

Because when Component B – whatever it is – increases, the 6-month yield decreases. Maybe Component B is a steepening, so a 1_σ_ change is an increase in long-term yields and a decrease in short-term yields.

Magician,

It is becoming clear now. Thanks.

For EOC 30, are we changing the slope or curvature? It can move parallel the way it is???

Get yourself come graph paper and plot Components A, B, and C (vertical axis) vs. maturity (horizontal axis). Then describe what each Component represents (e.g., steepening with an upward shift, flattening with the 5-year held constant, or whatever).

Thanks. I did. I understand now.

By the way, I put the numbers into Excel and used Solver to get the closest thing to a parallel shift with the constraint that the sum of the coefficients equals 1. (To define the closest thing to a parallel shift, I told it to minimize the standard deviation of the yield changes.) The resulting coefficients are:

• Component A: 0.7295
• Component B: −1.1457
• Component C: 1.4163

(Yes, there’s a slight rounding error.)