Dec 27, Learning objective: Differentiate among the three methods of mapping portfolios of fixed income securities.
Questions: The spot rate term structure is depicted below: 1. Finally, the returns VaR aka, risk is based on a yield volatility of basis points at all maturities and a confidence level of In this way, for example, the risk at one year is given by 1. Last edited by a moderator: Dec 27, We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads.
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Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. It only takes a minute to sign up. Map the cash flows of an instrument a coupon bond into buckets, get the zero rates interpolate if needed , find PV01, volatility of these zero rates, get the correlation matrix for the zero rates, find the total variance and calculate the VaR. The first one seems relatively simple.
However, what happens if there are many bonds in the portfolio? Is it OK to find individual VaRs for each bond and then simply sum them up? On the other hand, the second approach does deal with covariance of rates in different time horizons.
Mapping Cash Flows of a Zero Coupon Bond This workbook shows how to map a zero-coupon bond and obtain the VaR of the mapped cash flows. This sheet. We earlier learned that VaR calculation of a complex portfolio can be simplified In this article we will learn about mapping cash flows for a zero-coupon bond.
But there might be a small error due to bucket specification. Theoretically, we could get an infinite number of buckets.
But this is obviously very complicated. Note sensitivity and PV01 represent same concept. As you said, the second approach accounts for this diversification by bringing in the covariance, so it is just a generalisation of 1. You can have as many factors as you like but normally you are limited by the availability of liquid market data, and computational resources.
According to the RiskMetrics cash flow mapping method for the bond portfolio, the correlation matrix not covariance matrix includes the key time 1m, 3m, 6m, 1y
For example, the cash flow at 2. This formula closely resembles the foreign currency forward formula. Morgan, The aggregate of the Risk Weighted Assets will be taken into account for reckoning the minimum capital ratio. The square root of the sum of this column 6.