Yield curve methodology

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Contents

Introduction

FIA handles attribution over multiple yield curves in a very powerful and flexible manner. The program allows

Each of these topics is covered in more detail below.

Specifying which yield curves to use

Assuming that you have set up one or more yield curves in the yield curve file, and that each curve has been given a suitable name, you may link as many curves as you wish to the securities in your portfolio.

To do this, edit field 11 (labelled yield curve) in the security master file and insert the names of the curves that you wish to use for attribution. FIA enforces the following rules:

Attribution on risk-free (or base) curves

Attribution on sector and credit curves

Security-specific attribution

In cases where a yield to maturity is supplied for all securities in the portfolio and benchmark, FIA can calculate security-specific returns. These returns are due to changes in the spread between whatever curve(s) are associated with the security, and the security's actual market yield, which may not lie on the security's pricing curve.

For instance, an A-rated corporate bond may be priced from a suitable A-rated sector curve. However, the bond's actual yield may lie some distance away from the yield implied by reading off a yield from that curve at the bond's maturity. Such differences typically occur for security-specific reasons, and the returns generated by changes in this security-specific spread are called security-specific returns.

To include security-specific returns in your attribution reports, ensure that

Security-specific attribution can be run in conjunction with as many curves as required.

Z-spread attribution

In some cases you may wish to run attribution using a z-spread curve. The z-spread is the extra spread that must be added to all maturities on the risk-free (or base) curve to ensure that the price of the security calculated using this curve equals the price of the security in the marketplace. If the z-spread is accurate, the security return calculated by FIA should exactly equal the supplied return, and residual will be zero - although market noise usually means this is unlikely to occur.

For a particular security at a given date, a value for its z-spread can be supplied in column 13 of the weights and returns file.

To include z-spread returns in your attribution reports, ensure that

Z-spread attribution can be run in conjunction with as many curves as required.

Limitations

Security-specific attribution and z-spread attribution cannot be run at the same time. 

Use of a z-spread generates a zero-coupon curve from which securities can be priced. In contrast, a YTM cannot be used for security pricing as it includes the distorting effects of coupons. Therefore the two approaches are not consistent and cannot be combined.

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