Chapter 7 - 1 1 2 3 4 5 6 7 8 Chapter 7 Introduction to...

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1 Chapter 7 – Introduction to Measurement of Interest Rate Risk 1. Full Valuation (scenario analysis) approach for measuring interest rate risk: 1. Begin with the current market yield and price 2. Estimate hypothetical changes in required yields (parallel, steep, inverted etc.) 3. Re-compute bond prices using a valuation model with the new required yields 4. Compare the resulting price changes 5. For a portfolio of bonds, this procedure is repeated for every bond 6. For bonds with different maturities, yield changes can be different 7. This approach is dependent on a “quantitative model” or “black box”. 8. What are some of the problems with this approach? 2. Price Volatility Characteristics of Option Free Bonds 1. Price/Yield relationship is convex 2. Percentage price change is not the same for all bonds 3. For small changes in yield, the % price change for a given bond is roughly the same 4. For large changes in yield, % price change is not the same for increase vs decrease 5.
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