LOS i: Explain how yield volatility is forecasted.

Q1. 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 standard deviation of recent daily yield changes.

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

Q2. 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)   absolute regression chart highlight models.

C)   autoregressive heteroskedasticity models.

Q3. 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 autoregressive conditional heteroskedasticity (ARCH) model.

C)   An implied volatility model.

Q4. 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 most recent observations.

B)   Use only the most recent observations.

C)   Give increased weight to the implied volatility measure.

LOS i: Explain how yield volatility is forecasted. fficeffice" />

Q1. 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 standard deviation of recent daily yield changes.

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

Correct answer is 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.

Q2. 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)   absolute regression chart highlight models.

C)   autoregressive heteroskedasticity models.

Correct answer is C)

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

Q3. 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 autoregressive conditional heteroskedasticity (ARCH) model.

C)   An implied volatility model.

Correct answer is B)

ARCH is commonly used with econometric forecasting techniques.

Q4. 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 most recent observations.

B)   Use only the most recent observations.

C)   Give increased weight to the implied volatility measure.

Correct answer is A)

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

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