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Chapter 2 - Chapter 2 Risks Associated With Investing in...

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1 Chapter 2 Risks Associated With Investing in Bonds 1. Key risks – Interest rate, call and prepayment, yield curve, reinvestment, credit, liquidity, exchange-rate, volatility, inflation and event 2. CR = YTM => PRICE = PAR: Discount, Premium and Par value – p1 3. Bond features that affect interest rate risk: 1. Maturity: The longer the bond’s maturity, the greater the bond’s price sensitivity to changes in interest rates – p2 2. Coupon rate: The lower the coupon rate, the greater the bond’s price sensitivity to changes in interest rates. Zero coupon bonds have the maximum price sensitivity – p3 4. Price of a callable bond = price of an option free bond – price of the embedded option 5. Floating rate securities have less interest rate risk. Within floating rate securities, longer the reset date (6 months compared to monthly), greater the price sensitivity. –p4 6. Approximate percentage price change for 100bps change in yield (duration) = 1.
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