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FRM Part II · FRM Exam Part II · Regression Hedging and Principal Component Analysis

A risk manager regresses daily changes in the yield of a client's 10-year corporate bond position (dependent variable) on daily changes in the 10-year Treasury yield (independent variable). When constructing a hedge using this regression, what does the estimated slope coefficient represent?

The slope is the expected change in the corporate bond yield, in basis points, for a one basis point change in the Treasury yield. It is a sensitivity used to scale the hedge, not the explained variance, the intercept, or the correlation.

  1. AThe expected change in the corporate yield in basis points for a one basis point change in the Treasury yieldCorrect
  2. BThe percentage of corporate yield variance explained by the Treasury yield
  3. CThe expected corporate yield when the Treasury yield is zero
  4. DThe correlation between the two yield changes

Explanation

In a yield-change regression the slope (beta) measures the sensitivity of the dependent yield change to the independent yield change. The R-squared gives explained variance, the intercept is the constant term, and correlation equals beta only when volatilities are equal.

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