Question

Your boss at a fixed income management firm shows you a note.

The note reads. Hedge portfolio with Nelson and Siegel.
∂P∂β0+q1∂H1∂β0+q2∂H2∂β0=0
∂P∂β2+q1∂H1∂β2+q2∂H2∂β2=0
what does this mean
O The boss believes that a favorable change in the slope of the yield curve is likely.
O The boss believes that a favorable change in the level of the yield curve is likely.
O The boss believes that a favorable change in the curvature of the yield curve is likely.
O The boss believes that a unfavorable change in the slope of the yield curve is likely.

Answer 1

The boss believes that a favorable change in the curvature of the yield curve is likely. The correct answer is O The boss believes that a favorable change in the curvature of the yield curve is likely.

Step-by-step explanation:

The given equations are as follows:

• ∂P∂β0+q1∂H1∂β0+q2∂H2∂β0=0
• ∂P∂β2+q1∂H1∂β2+q2∂H2∂β2=0

These equations suggest that the boss believes that a favorable change in the curvature of the yield curve is likely. The terms ∂P∂β0 and ∂P∂β2 refer to the partial derivatives of the portfolio value with respect to two different factors, β0 and β2, which are related to the slope and curvature of the yield curve, respectively.

The terms q1∂H1∂β0, q1∂H1∂β2, q2∂H2∂β0, and q2∂H2∂β2 represent the sensitivities of the hedge portfolio to those factors. By setting these equations equal to zero, it indicates that the boss expects the portfolio to be protected or hedged against changes in the yield curve.