Daily Speculations

The Web Site of Victor Niederhoffer & Laurel Kenner

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7/2/04
James Sogi: Term Structure of Interest Rates

Here are a couple of references on the term structure of interest rates which deal with the idea of comparative securities pricing.

At the bottom of McCulloch's site are some nice data tables with yield curve data. One interesting story he told was that the Cpi was quoted wrong at BLS due to computer error on air conditioning sales, making the treasury TIP sale too cheap in 2000. He mentions that future estimates of CPI may make certain TIPS attractively priced where different expectations are priced in. http://economics.sbs.ohio-state.edu/jhm/ts/ts.html

http://www.fenews.com/fen4/analyzing.html is a short 1998 F'inancial Engineering News bit discussing data problems and pricing conventions in deriving a good yield curve to identify mispricing in bonds in the area of comparative securities pricing. "The term structure of interest rates relates the "pure price of time". Having a very precise view of the price of time goes along way toward helping them identify whether a security is being priced correctly, or whether an arbitrage opportunity exists. Because of the nature of fixed income securities, traders can easily strip apart and sell the cash flows of a security that is underpriced, or synthesize a security that is overpriced. As a result, traders gain competitive advantage only by having the best possible view of the term structure of interest rates."

"In theory, bootstrapping a zero curve from U.S. Treasury data should be a relatively straightforward process. In practice, however, it is much more difficult due to the characteristics of the market data reported for these instruments. When bootstrapping from Treasury bills, notes and bonds, you are confronted with three data-related issues:

Commodity Spread

Commodity contracts have a price spread along their maturities related to interest, inflation expectations, supply, and investor error and panic. For example the oil spread, a short near, long far might; have been a good spread, as Bud noted, with much lower price on forward with "backwardation". I can see that if the forward were bought in a currency such as yen that was artificially held low or Chinese, you could amplify your return with an additional discount from the artificial currency discount and artificially low interest rate reducing carry.. I think this is what e's point was some weeks back.

Bonds Many thanks to Chair, e and Z for post on Bonds in May.

e said on May 14, the _exact_ day of the low close bottom, "I knew it was a terrific opportunity to cover and go long and to press the bet today."

And Z and Vic said a few days earlier, "I actually started buying for my unleveraged personal account, last week. :) gz

Victor Niederhoffer wrote:

below round numba at 9929 for second time in 2 years, and greensward probably buying as am i. v"

Classic case of the old speculators taking out the canes. Seems like the near 100 point rise in interest rates from 3/17 to 5/14 over-discounted a years worth of 25pt fed moves. Deleveraging was noted on the list then. This was confirmed by the bonds going up when the Fed raised rates. That would not be the common expectation.