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The spot curve is currently upward sloping. Because you think the Fed will be raising short-term interest rates soon you want to take advantage of
The spot curve is currently upward sloping. Because you think the Fed will be raising short-term interest rates soon you want to take advantage of short-term yields rising relatively more than long-term yields, but you don't want to be exposed to changes in the general level of interest rates 2. What trading strategy should you put on to profit from this view? a. b. Your choice of assets are a two-year zero with a YTM of 1.5% and a ten-year zero with a YTM of 2.5%. Assume annual compounding and that each asset has a face value of F = 100. With these two assets, describe the positions (long or short) you would take in each of them to implement your trading strategy Now we'll do this strategy step by step c. First calculate the prices of each asset d. Now calculate the dollar duration for each asset e. Write the one-equation formula you are going to use to solve for as a function of N2 and 10 f. Assume that you already have a 1-unit position in the ten-year zero (so N10-1 or +1 depending if you're short or long it, respectively). Now solve the one-equation formula for the hedge ratio, N2/N1o0 g. Now that you know N2 and N1, calculate the value of your portfolio. This can be negative if you put on a large short position Now after putting on this trade, say the YTM on the two-year zero increases from 1.5% to 2.5% (assume the change was overnight, so the two-year zero is still a two-year zero, and same for the ten-year). What's your portfolio value now? If you decide to close out your position after the yield change, what's your dollar profit? h
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