Explain why when comparing futures rates to forward interest rates for the same tenor, a convexity...

Explain why when comparing futures rates to forward interest rates for the same tenor, a convexity adjustment is required.

Explain why collateral requirements will increase in the OTC market as a result of new regulations introduced since the 2008 credit crisis.

Solutions

Expert Solution

Comvexity adjustment is needed because of non linear relationship which is existing between the bond prices and the yield.

Convexity adjustment is a change which is made which will be made to Forward interest Yield in order to get expected future rate or yield. Convexity adjustment is the difference between the forward interest rates and the future interest rates and these differences are to be added to the forward interest rate in order to get to the Future interest rate and it is needed because there will be non linear relationship, which would be existent between Bond prices and the yield.

2. Regulations require most of over the counter transaction to be cleared by CCP when they will be entered between various Financial institutions.

When various financial transactions will be cleared by ccps, they will be requiring a large amount of margin requirements and these margin requirements will be helping in order to secure as there will be larger collateral requirements due to the credit market crash in order to protect over the counter exchange transactions and netting effect

when there would be a large number of counter party transactions it will be leading to a large number of netting and increase in the collateral in the books.

jeff jeffy answered 1 year ago

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