Yield Curve Risk is the potential for financial losses in a fixed-income portfolio or interest-rate sensitive crypto instruments due to adverse changes in the shape, slope, or level of the yield curve. Its primary purpose is to identify and quantify the exposure of an investment portfolio to fluctuations in interest rates across different maturities.
Mechanism
This risk manifests when yields for different maturities shift disproportionately, such as when short-term rates rise while long-term rates fall, causing a curve inversion, or when the entire curve moves upward or downward in a parallel fashion. Such movements alter the present value of future cash flows, consequently affecting bond prices and the profitability of strategies involving borrowing or lending crypto assets at various terms.
Methodology
Managing yield curve risk involves employing duration and convexity analysis to assess portfolio sensitivity to rate changes, alongside strategic positioning through techniques like barbell or laddering. In crypto, where traditional yield curves are nascent, this methodology extends to analyzing lending rates across different decentralized finance (DeFi) protocols and terms, utilizing derivatives to hedge against interest rate volatility, and adjusting asset allocations based on expectations for future crypto borrowing costs.
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