Calculating effective duration in a binominal tree income, Robert, totally, effective, 304

svgleeson

On page 304 of the fixed income curriculum (and page 198 of Schweser) in step 3, why are we constructing a binomial tree on the "yield curve"?

Why yield curve? I guess I'm totally lost, but I thought we built the tree using the one-year T-bill.

Thanks.

- Robert

neil1234

Schweser practice exam 3, question 5, page 126-7:

Step 2 (of 5):

Correct answer is "Impose an upward parallel shift in the on-the-run Treasury yield curve of 100 bps."

Incorrect answer is "Add 100 basis points to each of the 1-year rates in the interest rate tree to derive a modified tree."

Why is the incorrect answer incorrect? Aren't we adjusting the 1 year rates in the tree?

- Robert

yodacaia

um, when we are trying to find effectie duration,
we gotta shock the curve dont we?
we shock it once, we get a new curve, so we construct a new tree, we then colaberate the tree with OAS.
we shock it again, opposite direction, we get a new curve, and a new tree, then we again colaberate the tree with OAS.

I think this is what you are asking right?

thecfawannabe

We do not build tree using one year T-Bill, there is a lot more to it, many bills, or even other instruments, if you want read up on that...

But I think I get what is confusing you..

Let me see if this statement helps

"Shocking up the yeild curve by X percent is the same thing as moving each of the SPOT rates X percent. Remember the yeild curve is a complex avg of the SPOT rates."