F303_Class_14

F303_Class_14 - Class14 AndreyUkhov IndianaUniversity 1...

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1 F303 – Intermediate Investments Class 14 Interest Rate Sensitivity and Bond Duration Andrey Ukhov Kelley School of Business Indiana University
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2 Outline of This Subject Interest rate risk. Interest rate sensitivity. Concept of Duration. Calculating Durations. Rules of Duration.
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3 Interest Rate Risk  There is an inverse relationship between bond prices and yields – high yields imply low prices . This relationship becomes fundamental when considering that interest rates fluctuate substantially. The capital gains or losses that result from these interest rate movements, make investment risky. This is true even if the coupon and principal payments are guaranteed.
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4 Interest Rate Sensitivity Bond prices and yields are inversely related; Not symmetric relationship : An increase in a bond’s yield to maturity results in smaller price decline than the price gain associated with a decrease of equal magnitude in yield; For a 1-year zero coupon bond P = 1000/(1+Y): Yield 10% 15% 20% Price 909.09 869.57 833.33 Change in Price 39.53 36.23 Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds;
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5 Interest Rate Sensitivity As maturity increases, price sensitivity to yield changes increases at a decreasing rate; Interest rate risk is inversely related to the bond’s coupon rate; Bond prices are more sensitive to changes in yields when the bond is selling at a lower initial yield to maturity.
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This note was uploaded on 10/14/2009 for the course EECS 303 taught by Professor Henchen during the Winter '09 term at Northwestern.

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F303_Class_14 - Class14 AndreyUkhov IndianaUniversity 1...

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