Yield surface

[Batsirai Kapembeza]

Hello,

The core reading states that one method of performing a check for an anomaly switch in active bond management is to use yield models and under the yield models approach it states that;

"Rather than compare a bond’s yield with a redemption yield curve it can be compared with one of the alternatives such as a yield surface or par yield curve."

My someone please kindly explain what a yield surface is in this context. Thanks.

 

[Colin McKee]

I think a yield surface is a three dimensional shape where bonds are shown by term and by coupon (X and Y) and the GRY is plotted as the Z axis. Since tax treatment affects the GRY of a bond (big coupons are unpopular, small coupons are very popular) this can make the GRY dependent on the coupon. So a surface splits this effect out.
I very much hope you wont have to draw one in the exam

 

[David Wilmot]

I very much hope you wont have to draw one in the exam

Yes... quite Colin!

FYI ... If you want to read up more on this (for interest, rather than in preparation for the exam) then you might like to start with the Report of the Fixed Interest Working Group in the British Actuarial Journal Vol 4 No 2 (June 1998) an extract of which is attached. Enjoy!

 

[Batsirai Kapembeza]

Thanks a lot. Much appreciated.