Fixed Income【Reading 49】Sample 2012

Mechanic

Suppose that there is a nonparallel downward shift in the yield curve. Which of the following best explains this phenomenon?

A) The absolute yield increase is different for some maturities.

B) The absolute yield decrease is different for some maturities.

C) The yield decrease is the same for all maturities.

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A nonparallel downward yield curve shift indicates an unequal yield decrease across all maturities, i.e., some maturity yields declined more than others.

spartan1

Which of the following is NOT an accepted method for forecasting yield volatility? Using:

A) the simple average of recent squared daily yield changes.

B) the absolute difference between the spot and forward rate.

C) the standard deviation of recent daily yield changes.

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To forecast yield volatility, an analyst should compute a recent standard deviation of yield changes. It is acceptable to assume the mean yield change is zero and use the average of recent squared rate changes. This can be a simple average or a weighted average where the more recent squared changes are weighted more heavily.

spartan1

Which of the following is the most questionable assumption associated with the implied yield volatility metric? Implied yield volatility assumes:

A) that the bond pricing model used is correct.

B) that the option pricing model used is correct.

C) that the yield curve is flat.

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If the observed price of an option is assumed to be the fair price and the option pricing model is assumed to be the model that would generate the fair price, then the implied volatility is the yield volatility that, as an input to the option pricing model, would produce the observed option price.

spartan1

To estimate yield volatility, an analyst may use historical yields or an implied yield volatility calculated from current market conditions. Identify the pair of terms below that correctly matches a key ingredient in each estimation process with the process itself.

A) Historical yield volatility: The standard deviation formula. Implied yield volatility: Derivative prices.

B) Historical yield volatility: Duration. Implied yield volatility: A series of log ratios of daily rates.

C) Historical yield volatility: Derivative prices. Implied yield volatility: The standard deviation formula.

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The historical yield volatility method uses the standard deviation formula. The implied yield volatility method uses derivative prices. In the latter method, the current derivative prices are entered into a formula along with other observed variables. The series of log ratios of daily rates is associated with the historical yield volatility. Duration is not directly relevant.

spartan1

Suppose that market participants give the most importance to the most recent movements in yield. Which of the following best describes how the historical yield estimate should be adjusted?

A) Use only the most recent observations.

B) Give increased weight to the most recent observations.

C) Give increased weight to the implied volatility measure.

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In this way the forecasted volatility reacts faster to a recent major market movement.

spartan1

Which of the following is the most appropriate model when we assume that volatility today depends only upon recent prior volatility?

A) A time weighted historical volatility model.

B) An implied volatility model.

C) An autoregressive conditional heteroskedasticity (ARCH) model.

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ARCH is commonly used with econometric forecasting techniques.

spartan1

Yield volatility has been observed to follow patterns over time. One class of statistical techniques used to forecast those patterns is called:

A) autoregressive capital hedging models.

B) autoregressive heteroskedasticity models.

C) absolute regression chart highlight models.

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Autoregressive heteroskedasticity (ARCH) models incorporate past patterns of yield volatilities to forecast future patterns.

spartan1

Which of the following is a major consideration when the daily yield volatility is annualized?

A) The appropriate time horizon.

B) The shape of the yield curve.

C) The appropriate day multiple to use for a year.

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Typically, the number of trading days per year is used, i.e., 250 days.

spartan1

Which of the following is the most important consideration in determining the number of observations to use to estimate the yield volatility?

A) The liquidity of the underlying instrument.

B) The shape of the yield curve.

C) The appropriate time horizon.

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The appropriate number of days depends on the investment horizon of the user of the volatility measurement, e.g., day traders versus pension fund managers.

spartan1

For a given three-day period, the interest rates are 4.0%, 4.1%, and 4.0%. What is the yield volatility over this period?

A) 0.0349.

B) 0.0577.

C) 0.0000.

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The yield volatility is the standard deviation of the natural logarithms of the two ratios (4.1/4.0) and (4.0/4.1) which are 0.0247 and –0.0247 respectively. Since the mean of these two numbers is zero, the standard deviation is simply {[(0.0247)2 +(-0.0247)2]/(2-1)}0.5=0.0349.