Lecture_16-spring

Lecture_16-spring - Bond pricing, Duration What's up with...

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Bond pricing, Duration
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What’s up with the Fed? Wondering about the Fed's latest efforts to prevent a general financial meltdown? Have questions about where it will all end? Our local Fed expert, Steve Cecchetti, will give his interpretation of recent developments at noon Thursday (3/20) in International Hall.
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Interest rate risk We now consider the risk and return characteristics of bonds and bond portfolios. • Even though cash flows are pre-determined,bond investors are exposed to the risk of falling prices and resulting low returns. • Interest rate risk makes bonds risky instruments. – When interest rates rise, bond prices fall. – When interest rates fall, bond prices rise. • The first question is: rise/fall by how much?
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Change in Bond Price as a Function of Change in Yield to Maturity
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Inverse relationship between price and yield. An increase in a bond’s yield to maturity results in a smaller price decline than the gain associated with a decrease in yield. Long-term bonds tend to be more price sensitive than short-term bonds ( B has longer maturity and exhibits higher sensitivity than A) Bond Pricing Relationships
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As maturity increases, price sensitivity increases at a decreasing rate (B is 6 times maturity of A, but has less than 6 times sensitivity) Price sensitivity is inversely related to a bond’s coupon rate (B has higher coupon than C and B has lower sensitivity) Price sensitivity is inversely related to the yield to maturity at which the bond is selling (C versus D, C has higher YTM and is less sensitive to changes in yields) Bond Pricing Relationships (cont’d)
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Duration Duration or Macaulay duration is a measure of the effective maturity of a bond. • Duration is the weighted average of the times until
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Lecture_16-spring - Bond pricing, Duration What's up with...

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