Jul 12

Key rate shift technique – 9 min screencast

by David Harper, CFA, FRM, CIPM

This screencast explains Tuckman's key rate shift technique example (Table 7.1 in the FRM assigned reading). The example starts with a fully-amortizing bond: Price = $100,453.13 = PV(5%/2, 60 periods = 30 years,-3,250 semi-annual coupons, 0 = fully-amortizing) = $100,453.13.

The key rate shift technique amounts to:

Pick several key rates; e.g., 2, 5 10 and 30 year
Make a rule about treating neighbor rates; e.g., linear interpolation
Re-price the bond based on shocking only the key rate (plus its neighbors) but leave the rest of the curve alone. This is the essence of key rates: instead of assumes a parallel shift in the yield curve (duration is the single factor that treats the entire yield curve), we shock/shift selected key rates

Then compute:

Key rate 01 ($). Analogous to DV01 (a.k.a., PVBP). The difference is: DV01 refers to dollar change in bond price for a one basis point shift in the entire yield curve; KR01 refers to dollar change in bond price for only the shifted key rate (plus neighbors).
Key rate duration. Same as duration but only for the key rate; i.e., what is the approximate percentage change in bond price given a one percent shift/shock to only the key rate (plus neighbors).

Screencast: