assumption of value duration of bond portfolio

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Dan
Posts: 25
Joined: Mon Oct 24, 2011 4:00 pm

assumption of value duration of bond portfolio

Postby Dan » Wed Jul 11, 2012 10:17 am

Hi Carol,

As you said in the book, bond traders typically use taylor expansion to approximate the effect of a change in market interest rates on their bond portfolio P&L. And to use this, the traders must assume that all the bond yields change by the same amount when the zero curve shifts parrallel. I'm not clear as to what is THE zero curve you are refering to here. Shouldnt there be multiple relevent zero curves for a bond portfolio which contains bonds of different credit ratings.

Thanks Carol.

Dan

coalexander
Posts: 815
Joined: Sun Sep 28, 2008 10:30 pm

Re: assumption of value duration of bond portfolio

Postby coalexander » Thu Jul 12, 2012 11:58 am

Yes, that's true. So bond portfolios are typically categorized according to some rating 'bucket' BBB, and the BBB zero curve is used.

Cheers, Carol

Dan
Posts: 25
Joined: Mon Oct 24, 2011 4:00 pm

Re: assumption of value duration of bond portfolio

Postby Dan » Thu Jul 12, 2012 12:04 pm

So typically we use a representative credit rating for the bond portfolio as a whole and the corresponding zero curve for that credit rating. Usually BBB zero curve is used. Is this what you meant?

coalexander
Posts: 815
Joined: Sun Sep 28, 2008 10:30 pm

Re: assumption of value duration of bond portfolio

Postby coalexander » Thu Jul 12, 2012 12:18 pm

Yes, but not usually BBB. Separate portfolios, from AAA down to sub-investment grade...

Dan
Posts: 25
Joined: Mon Oct 24, 2011 4:00 pm

Re: assumption of value duration of bond portfolio

Postby Dan » Tue Jul 17, 2012 9:06 am

Hi Carol,

Just to make sure i totally understand this, so if a bond portfolio contains bonds of multiple credit ratings, as you suggested, we choose a representative credit rating for this overall portfolio -- this representative credit rating could be anything on the credit spectrum i.e. AAA to junks. Is this correct?

Secondly, in Peter's thread entitled PV01 in vol.3 forum, he asked about which zero curve to use when calculating PV01 for a bond portfolio of different credit ratings. In your reply, you mentioned about base curve plus spread curves.

So for my question in my first post under this thread, I wonder whether this zero curve refers to the base curve. If the base curve shifts parralle, then for traders to use taylor approximation for portfolio P&L, they must assume that this parralle shift of the base curve would induce the same amount of yield changes on ALL bonds in the portfolio.

I just haven't come across this concept of "representative credit rating for a bond portfolio" and then I read peter's thread and found the base curve explanation given above seems to make sense to me. I'm just somewhat confused.

If you could help clarify, that'd be superb!

Many thanks always,

Dan

coalexander
Posts: 815
Joined: Sun Sep 28, 2008 10:30 pm

Re: assumption of value duration of bond portfolio

Postby coalexander » Wed Jul 18, 2012 6:31 pm

Hi Dan

Yes, your first statement is correct.

The base curve is usually LIBOR or Bank of England zero curve for government inter-bank lending [see websites I refer to in the book), where the curve can be easily interpolated fairly accurately -- at least, given accurate LIBOR rates, ha ha.

The credit curves have fewer instruments, especially at lower credit ratings, and some maturities may be missing. Also historical data is not so easily obtained. So usually we take historical moves on the base (can be parallel, or based on principal component analysis) and represent shifts on the other credit rated curves relative to this, given whatever spread data at different maturities is available.

Cheers, Carol

ninjapunit
Posts: 20
Joined: Fri Sep 16, 2011 5:12 am

Re: assumption of value duration of bond portfolio

Postby ninjapunit » Thu Jul 19, 2012 7:43 am

"at least, given accurate LIBOR rates" ....Hahaha...good one Carol!

Dan
Posts: 25
Joined: Mon Oct 24, 2011 4:00 pm

Re: assumption of value duration of bond portfolio

Postby Dan » Wed Jul 25, 2012 10:11 am

Hi Carol,

Many thanks for the explanation. I am clearer now.

Dan


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