Explain how to measure a bond's sensitivity to each factor that moves the yield curve, and how to use those sensitivities to manage yield curve risk
The idea
Yield curve changes are summarised by a few factors: level, a parallel shift; steepness, a change in the gap between short and long yields; and curvature, a change in the middle relative to the ends. Exposure to each can be measured with key rate durations, the sensitivity to a move in one point of the curve with the others held fixed. Their sum equals effective duration. The estimated change in value is minus the sum of each key rate duration multiplied by its yield change. A manager can neutralise or deliberately take a shape view by rebalancing key rate exposures while leaving total duration unchanged. Watch the sign: rising yields reduce value.
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