Query - Key Rate Exposure

[Avishek]

Hi David

In your video under LO 24.3 Example shown, you have mentioned "security" FV is 0, which is normally the case for "Mortgage Security". In case it was a normal security, the FV should have been $ 100,000 right? Please explain.

Thanks, Avi

P.S. Is key rate exposures calculated only on Mortgage Secs?

 

[Avishek]

Also I didn't understand the direction of the Price. It's contradicting the thumb rule which states:
"Coupon Rate > YTM will lead to Price > Par Value and vice versa"

The Video clearly contradicts that scenario - even when am computing the Price gives me a value less than the PAR of $100,000.

While in the book, there is another example with slightly different value which is giving me right value where in, the Coupon Rate > YTM and the calculated Price > Par value.

Please clarify this scenario!

Thanks again and sorry for bugging time and again!!!

Rgds, Avi

 

[David Harper CFA FRM]

Avi,

Although the slide and the calculations are correct, I may have misspoken in the movie. See this thread. I must have misspoken due to the confusion it created

Specifically,

* You are correct. For a typical bond, the par value is the future value (FV); e.g., $100, $1000. It's the FV because its the final cash inflow (from the issuer like a company, as in corporate bond, to the investor). For a typical mortgage bond (fixed-rate, level-payment, fully amortizing bond), the FV=0 because the principal is reduced along the way, instead of returned at the end in one lump sum. So, UNLESS the QUESTION SPECIFIES MORTGAGE, assume like we typically do (FV=par or face)

* No, key rate approach is indifferent to the particular bond. Same principle applies, and don't lose sight of the underlying principle of key rate: the bond is being repriced (revalued) based on a simplifying assumption about the yield curve; i.e., instead of changing the yield curve meticulously at every point, a few key rates are "shocked" (e.g., 1 bps) and decision rules (e.g., linear interpolation) are applied to the neighboring rates. So, you can do that with any bond

* You are right: for a typical bond (par = 100, 1000), the Coupon > YTM implies Price > Par.

Sorry for confusion my speaking caused (not just for you), but don't let the fully amortizing nature of a mortgage undo the other ideas....

David

 

[Avishek]

Thanks a lot David. Got a bit confused!