Reading 56: LOS i ～ Q1- 4

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

A)   autoregressive heteroskedasticity models.

B)   autoregressive capital hedging models.

C)   absolute regression chart highlight models.

D)   absolute reversion capital hedging models.

The correct answer was A)

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

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

A)   the standard deviation of recent daily yield changes.

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

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

D)   an average of recent squared daily yield changes weighting the more recent changes more heavily.

The correct answer was C)

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.

3.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)   Give increased weight to the implied volatility measure.

B)   Give increased weight to the most recent observations.

C)   Use a forward looking yield volatility measure.

D)   Use only the most recent observations.

The correct answer was B)

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

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

A)   An ARCH model.

B)   An implied volatility model.

C)   A time weighted historical volatility model.

D)   A forward looking volatility model.

The correct answer was A)

ARCH stands for autoregressive conditional heteroskedasticity. It is commonly used with econometric forecasting techniques.