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Problem 273 of 333HardFinanceP273
A level- and slope-neutral butterfly
A PCA of daily changes in the 2y, 5y and 10y yields gives loadings PC1 (level) and PC2 (slope) . 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?
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