Briefly discuss the following terms or concepts
I. Credit default swap
II. Subordination Clause
III. Value at Risk
IV. Term structure of interest rate.
V. Horizon analysis.
A credit default swap (CDS) is a financial derivative or contract that allows an investor to "swap" or offset his or her credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in the case the borrower defaults. Most CDS will require an ongoing premium payment to maintain the contract, which is like an insurance policy. (Investopedia)
II. Subordination Clause
A subordination clause is a clause in an agreement which states that the current claim on any debts will take priority over any other claims formed in other agreements made in the future. Subordination is the act of yielding priority.
III. Value at Risk
Value at risk (VaR) is a statistic that measures and quantifies the level of financial risk within a firm, portfolio or position over a specific time frame. This metric is most commonly used by investment and commercial banks to determine the extent and occurrence ratio of potential losses in their institutional portfolios.
Risk managers use VaR to measure and control the level of risk exposure. One can apply VaR calculations to specific positions or whole portfolios or to measure firm-wide risk exposure.
VaR modeling determines the potential for loss in the entity being assessed and the probability of occurrence for the defined loss. One measures VaR by assessing the amount of potential loss, the probability of occurrence for the amount of loss, and the timeframe.
For example, a financial firm may determine an asset has a 3% one-month VaR of 2%, representing a 3% chance of the asset declining in value by 2% during the one-month time frame. The conversion of the 3% chance of occurrence to a daily ratio places the odds of a 2% loss at one day per month.
IV. Term structure of interest rate
Term structure of interest rates, commonly known as the yield curve, depicts the interest rates of similar quality bonds at different maturities.
Understanding Term Structure Of Interest Rates
Essentially, term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. When graphed, the term structure of interest rates is known as a yield curve, and it plays a crucial role in identifying the current state of an economy. The term structure of interest rates reflects expectations of market participants about future changes in interest rates and their assessment of monetary policy conditions.
In general terms, yields increase in line with maturity, giving rise to an upward-sloping, or normal, yield curve. The yield curve is primarily used to illustrate the term structure of interest rates for standard U.S. government-issued securities. This is important as it is a gauge of the debt market's feeling about risk. The most frequently reported yield curve compares the three-month, two-year, five-year, 10-year, and 30-year U.S. Treasury debt. (Yield curve rates are usually available at the Treasury's interest rate web sites by 6:00 p.m. ET each trading day),
The term of the structure of interest rates has three primary shapes.
1. Upward sloping—long term yields are higher than short term yields. This is considered to be the "normal" slope of the yield curve and signals that the economy is in an expansionary mode.
2. Downward sloping—short term yields are higher than long term yields. Dubbed as an "inverted" yield curve and signifies that the economy is in, or about to enter, a recessive period.
3, Flat—very little variation between short and long term yields. Signals that the market is unsure about the future direction of the economy.
Horizon analysis uses scenario analysis to estimate the expected total return, or horizon return, of a bond or portfolio over some investment horizon.
The horizon analysis framework allows portfolio managers to project the performance of bonds on the basis of the planned investment horizon and expectations concerning levels of risk, interest rates, reinvestment rates and future market yields.
By breaking down expected returns into scenarios, it is possible to evaluate which bonds would perform the best over the planned investment horizon – something that would not be possible using the yield to maturity. This scenario analysis enables the portfolio manager can see how sensitive a bond’s performance will be to each scenario, and whether it would be likely to meet their goals over the investment horizon.
Don't forget to refer your friends to www.solutionwheels.com and also share with other people and your colleagues. Regards
I. Credit default swap
A credit default swap (CDS) is a financial derivative or contract that allows an investor to "swap" or offset his or her credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in the case the borrower defaults. Most CDS will require an ongoing premium payment to maintain the contract, which is like an insurance policy. (Investopedia)
II. Subordination Clause
A subordination clause is a clause in an agreement which states that the current claim on any debts will take priority over any other claims formed in other agreements made in the future. Subordination is the act of yielding priority.
III. Value at Risk
Value at risk (VaR) is a statistic that measures and quantifies the level of financial risk within a firm, portfolio or position over a specific time frame. This metric is most commonly used by investment and commercial banks to determine the extent and occurrence ratio of potential losses in their institutional portfolios.
Risk managers use VaR to measure and control the level of risk exposure. One can apply VaR calculations to specific positions or whole portfolios or to measure firm-wide risk exposure.
VaR modeling determines the potential for loss in the entity being assessed and the probability of occurrence for the defined loss. One measures VaR by assessing the amount of potential loss, the probability of occurrence for the amount of loss, and the timeframe.
For example, a financial firm may determine an asset has a 3% one-month VaR of 2%, representing a 3% chance of the asset declining in value by 2% during the one-month time frame. The conversion of the 3% chance of occurrence to a daily ratio places the odds of a 2% loss at one day per month.
IV. Term structure of interest rate
Term structure of interest rates, commonly known as the yield curve, depicts the interest rates of similar quality bonds at different maturities.
Understanding Term Structure Of Interest Rates
Essentially, term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. When graphed, the term structure of interest rates is known as a yield curve, and it plays a crucial role in identifying the current state of an economy. The term structure of interest rates reflects expectations of market participants about future changes in interest rates and their assessment of monetary policy conditions.
In general terms, yields increase in line with maturity, giving rise to an upward-sloping, or normal, yield curve. The yield curve is primarily used to illustrate the term structure of interest rates for standard U.S. government-issued securities. This is important as it is a gauge of the debt market's feeling about risk. The most frequently reported yield curve compares the three-month, two-year, five-year, 10-year, and 30-year U.S. Treasury debt. (Yield curve rates are usually available at the Treasury's interest rate web sites by 6:00 p.m. ET each trading day),
The term of the structure of interest rates has three primary shapes.
1. Upward sloping—long term yields are higher than short term yields. This is considered to be the "normal" slope of the yield curve and signals that the economy is in an expansionary mode.
2. Downward sloping—short term yields are higher than long term yields. Dubbed as an "inverted" yield curve and signifies that the economy is in, or about to enter, a recessive period.
3, Flat—very little variation between short and long term yields. Signals that the market is unsure about the future direction of the economy.
(read more at Investopedia)
V. Horizon analysis
Horizon analysis uses scenario analysis to estimate the expected total return, or horizon return, of a bond or portfolio over some investment horizon.
The horizon analysis framework allows portfolio managers to project the performance of bonds on the basis of the planned investment horizon and expectations concerning levels of risk, interest rates, reinvestment rates and future market yields.
By breaking down expected returns into scenarios, it is possible to evaluate which bonds would perform the best over the planned investment horizon – something that would not be possible using the yield to maturity. This scenario analysis enables the portfolio manager can see how sensitive a bond’s performance will be to each scenario, and whether it would be likely to meet their goals over the investment horizon.
Don't forget to refer your friends to www.solutionwheels.com and also share with other people and your colleagues. Regards