14
There are two parts to your question and I'd like to answer them separately.
Curve Construction
On a daily basis, you can observe prices on a large variety of instruments, whose prices are driven by news and trading flows. Based on market prices of these instruments, there are a number of ways to create discount curves/forward curves. At a very high level (...
6
It is incorrect to use 1m euribor or O/N euribor in a 6m Euribor forward curve. You should only use instruments based on 6M euribor, such as 1x7 FRA, 6x12 FRA or swaps v 6m Euribor, as you have done in your second example. The actual 6m euribor fixing itself can be thought of as a 0x6 FRA out of spot.
Before the financial crisis basis between different ...
4
Let's step back and look at the reason for making a DV01 calculation first before answering the question;
The reason for making a DV01 calculation is to quantify what market movements has impact on the valuation of the trade.
Since the 'flat' forecast curve won't be affected by market movements the answer is (using pre-2008 methodology): The floating ...
4
Once upon a time, the banks used a fixing called LIBOR as a measure of the risk-free interest rate. Then the big hairy crisis came along and ate all our assumptions, leaving just the bones of the fixing (upon which everything else still fixes) and the mantle of risk-free rate proxy was passed on to a family of Overnight fixings, called Sonia, Eonia and -ahem-...
3
I don't think they are implying that future interest rates are predictable. They may be speaking of implied forward rates as predictors of future rates or, generally, of the yield curve as an expectation of the future path of short-term interest rates.
If $P(0,T_1)=1/(1+r_1)$ and $P(0,T_2)=1/(1+r_2)$ are the prices today of two "risk-free" zero coupon bonds ...
3
Which currency are you looking at ?
Say that your 1y swap would have yearly fixed payments vs 3M floating payments.
Your 1.5y swap would probably have:
a fixed payment 6m after effective date and another fixed payment 18m
after effective date
regular quarterly floating payments
Your curve was built with 1y and 2y swaps, nothing in the middle ? Then yes, ...
2
The short answer is that there's no consensus. A popular method is to shock each input instrument by 1 bp (i.e., change the futures rate by 1bp, the swap rates by 1bp, OIS rates by 1bp, etc.), rebuild the curve, and then reprice the instrument of interest to obtain its curve sensitivity. This of course is not quite a "parallel" shift of any curve (e.g., a ...
2
By no arbitrage, market participants need to agree on the values of the discount factor, even if they are using different conventions (day count, compounding period) to convert the discount factor into a rate.
For example, consider two discount factors computed using continuous compounding, where one is computed using the 30/360 day count (year fraction $t_{...
2
Equation 2 gives the annual zero rate for all tenors. In practice, people sometimes quote rates f less than one year using Equation 1, but in general , equation 2 is used.
1
Generally speaking there are more inputs that are required to precisely specify the multicurve structure, and they are potentially more important.
For example consider constructing a EUR interest rate curveset for 3 years, in the indexes EONIA, 3M EURIOBOR, 6M EURIBOR.
The information you have available are:
Some outright EONIA quotes in generic tenors; ...
1
It's difficult to see your screenshot. But I think you should just follow some real examples online instead of having people find out what's wrong on your side.
This is an excel example, go play with it.
webuser.bus.umich.edu/Organizations/FinanceClub/resources/BootstrappingMath.xls
1
I don't recommend linear interpolation of DFs and the swap rates you are applying this to are either against 12M libor which is illiquid or you are not accounting for Quarterly or Semi-Annual floating sides. And what I'm going to suggest uses a single curve framework which is long outdated. But that being said and given the nature of what's been asked...
...
1
Suppose you wanted to value a 5Y EUR IRS with a USD cash collateralised curve this is the broad process:
Get the 5Y EUR 3M / OIS basis, say this is 10bps: This establishes the discounting basis in the local (EUR) currency.
Now get the 5Y EUR/USD Cross-currency basis, say this is EUR 3M-IBOR - 40bps: This establishes your link to dollars.
Now get the 5Y ...
1
Your valuation date is $t=$ Thu 10-Nov-11. The swaps start on the spot date which is $t + 2$ business days = Mon 14-Nov-11. The usual approach is to extrapolate between $t$ and the first curve pillar, in a manner consistent with the interpolation method that you are using for representing your discount curve. For instance if you use linear interpolation of ...
1
Agree with Helin. For short term risk management a trader would be usually looking at delta to the forecast curve (i.e. swaps curve and government curve for a swaps/options trader), although he/she would also have delta risk to the OIS curve and also to curves of other currencies now that multi-currency collateralisation is quite common. Those other deltas ...
1
No it's just interpolation. In practice there isn't much disagreement among participants for something like one month 20yr forward rate.
1
You have
$\beta_1=\frac{1}{(1+r)^n}\frac{1}{(1+r)^\theta}$
and
$\beta_2=\frac{1}{(1+r)^n}\frac{1}{(1+\theta r)}$.
Both are equal when $\theta=1$. If you consider simple interest then go for $\beta_2$. If you would like compound interest within fraction of year then pick $\beta_1$.
However, because $\theta$ is between 0 and 1 then values $\beta$'s won't ...
1
You'll need to bootstrap a zero curve from your market data. This process is iterative in the sense that the implied zero rates for your short-term LIBOR rates are calculated before using those rates to bootstrap your zero rates implied by your FRAs. You will need to bootstrap for each time-point defined by your instruments.
A good reference for you would ...
1
You should use whatever currency in which the debt is denominated. Specifically, since it is the EUR currency and interest rate risk associated with the debt, some sort of EUR curve should be used.
Theoretically, if you are looking for the present value in USD, although the debt is denominated in EUR, you could convert future payments at the forward ...
1
Before the financial crisis, we used to assume that LIBOR is a risk-free rate and built swap curves in pretty much the same way your professor taught.
Nowadays, OIS discounting is the norm (actually depends on the exact collaterialization mechanism, but let's not go there...). Simply put, you need to have a 3-month LIBOR curve to project 3-month LIBOR ...
1
If you're bootstrapping and if there are bonds maturing on the same date, you should use only one. A good rule is to discard the older issue and keep the more recently issued securities.
If you're building a spline, then it really doesn't matter since you're building a best fit curve that best approximates the prices of all bonds.
Assuming the quotes you ...
1
The formula seems to be correct. Negative interest rates are not impossible in these days.
http://www.bloombergview.com/quicktake/negative-interest-rates
Have you checked the algorithm with values that produce positive rates? And in what area lie the negative ones?
In the case of negative interest rates the discount factors should be greater than one, of ...
1
Once upon a time, there was the One Curve. It was made of various instruments (Depos, Fixings, Futures, Swaps) and represented the One True Discount Rate for any given term. With that curve, and an appropriate interpolation method, it made sense to talk about expensive days, the curve up to 3m, etc.
But that world is long gone. When you create a 3m curve ...
1
It is not normal, for swaptions, your prices should be perfect or you open yourself up to arbitrage. Is Bloomberg calculating the swaptions with dual-curve stripping/bootstrapping? SWDF DFLT has a setting for that. If you are assuming in your model that your discount curve is the same as your forward rates curve, but Bloomberg is doing proper post-2006 OIS ...
1
varies from market to market and from company to company... The methodology differs even for the US Treasury market (the most largest & most liquid govt bond market). Generally speaking, the benchmark bonds (2y, 3y, 5y, 7y, 10y, and 30y on-the-runs) are traded very very heavily and readily available. Their prices are driven by supply-demand. Non ...
1
How are the future interest rates determined?
Two ways. 1) They are observed in the market, i.e. they are the best estimate of the market participants. One way is to use Bloomberg. 2) You can create your own discount curve and from that calculate the forward rates. Discount and forward curves for non-collateralized swaps must be consistent, otherwise ...
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