Curve Risk

[AbhishekJha]

What is Curve Risk? Can this be explained with example.

ANd what is DV01 ? Can this also be explained with example and how it is tied to Curve Spread?
In the text below, what is it meaning of non parallel shifts?

Curve risk is when the fixed income is hedged against parallel shifts in the yield curve (e.g., duration or DV01 hedged) but are exposed to non-parallel shifts such as twists or steepening/flattening.

 

[Lu Shu Kai FRM]

Hi @AbhishekJha ,

What is Curve Risk? Can this be explained with example.
- The answer to curve risk is in the text you quoted, "Curve risk is when the fixed income is hedged against parallel shifts in the yield curve (e.g., duration or DV01 hedged) but are exposed to non-parallel shifts such as twists or steepening/flattening."
- An example of steepening is given as (and explained nicely by BT's notes) - increase in long-term rates (such as 10Y and 30Y key-rates) greater than increase in short-term rates (such as 2Y and 5Y key-rates) OR decrease in long-term rates less than decrease in short-term rates. The flattening of the yield curve is just the opposite of the scenario I just mentioned.

And what is DV01 ? Can this also be explained with example and how it is tied to Curve Spread?
- I feel DV01 is best explained with two formulas:

• DV01 = - (D*P) / 10,000
• DV01 = - (1/10,000) * (ΔP/Δy)

Where D is modified duration, P is bond price, ΔP is change in bond price and Δy is change in yield. A formula definition of DV01 would be the dollar change in bond price per 1 basis point decrease in yield of the bond.

- I don't understand what you mean by curve spread, but I assume it is the difference between treasury bond yield and that of corporate bonds. This is referred to as the yield spread, a more common definition. As far as I know, I don't think DV01 has a formal tie in with yield spread, so you don't have to worry about that. The yield curve is more commonly known for its approximation to a bond's credit risk - the higher the yield spread, the greater the credit risk.