By Chounfhry M.
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Additional info for Fixed Income Securities and Derivatives Handbook. Analysis & Valuation
Example text
That is, when the cost of a marginal unit (say, of production) is above that of an average unit, the addition of a marginal unit increases the average cost. Conversely, the average cost per unit decreases if the marginal cost is below the average cost. The Spot and Forward Yield Curve From the preceding discussion of the relationships among bond prices, spot rates, and forward rates, it is clear, given any one of these sets, that it is possible to calculate the other two. 5, which are assumed to be observed in the market.
Calculating a forward rate is equivalent to estimating what interest rate will be applicable for a loan beginning at some point in the future. This process exploits the law of one price, or no arbitrage. Consider a loan that begins at time T and matures at T + 1. The process of calculating the rate for that loan is similar to the one described above. Start with the simultaneous purchase at time t of one unit of a bond with a term of T + 1 for price P (t, T+1) and sale of p amount of a bond with a term of T for price P (t, T ).
To calculate how much of a hedging instrument is required to get this type of protection, each bond’s BPV is used. This is important because different bonds have different BPVs. To hedge a long position in, say, $1 million nominal of a 30-year bond, therefore, you can’t simply sell $1 million of EXAMPLE: Calculating Hedge Size Using Basis Point Value Say a trader holds a long position of $1 million of the 8 percent bond maturing in 2019. 87596. 14477. 05549. Assuming that the yield beta is 1, what nominal value of the zero-coupon bond must the trader sell?