Problem bank

Problem 273 of 333HardFinanceP273

A level- and slope-neutral butterfly

  1. A PCA of daily changes in the 2y, 5y and 10y yields gives loadings PC1 (level) =(0.51,0.64,0.57)= (0.51, 0.64, 0.57) and PC2 (slope) =(−0.75,0.01,0.66)= (-0.75, 0.01, 0.66). The level factor has a standard deviation of 10.8 bp/day.

    (a) You short $10,000 of 5y DV01 and buy 2y and 10y DV01 so the trade has zero exposure to level and slope. How much 2y and 10y DV01 do you buy?

    (b) A colleague instead runs a 50/50 butterfly: short $10,000 of 5y DV01, long $5,000 each of 2y and 10y. What is its P&L on a one-standard-deviation rise in the level factor, with the other factors unchanged?