Class Note 11_S2010 - RSM 330 Investments Class Note 11 Bond Portfolio Management Maureen Stapleton CFA RSM 330_Class 12_Summer 2010 1 Plan for

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RSM 330 - Investments Class Note 11 – Bond Portfolio Management August 12, 2010 Maureen Stapleton, CFA 1 RSM 330_Class 12_Summer 2010
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2 Plan for Today Exam Review Session – Aug 12 at 8pm in WO 35 Measuring Interest Rate Risk – Duration and Convexity Active Bond Portfolio Strategies Barbells and Bullets – Riding the Yield Curve - Sector swaps - Anomaly Trading Recap of the course RSM 330_Class 12_Summer 2010
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The Relationship between Bond Price & YTM is not linear 3 RSM 330_Class 12_Summer 2010
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4 y 1 ) y 1 ( D P P + + - = y 1 D D * + = y D P P * - = Price change of a bond is proportional to duration and not to maturity More precisely,  if we denote D = modified duration  Duration/Price Relationship: RSM 330_Class 12_Summer 2010
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5 Over time, there are three determinants of the bond price. P = f(y, cash flow, T) Your holding period return is impacted by a change in interest rates: P + P = f(y + y) and y P. Measures of sensitivity to interest rate risk: dP dP 1 dy or dy P For example, suppose that dP/dy = 6000 and dP 1/dy P = 10. Then for a small change y, the price change is roughly P = 6000 y and the percentage price change is P/P = 10 y. − ∆ RSM 330_Class 12_Summer 2010
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6 Duration Macaulay Duration : “the average time at which you receive the cash flows from bond”; Alternatively, it’s the time at which you receive half the PV of cashflows Macaulay Duration = 1 · w 1 + 2 · w 2 + · · · + T · w T where the weights are and CF t is the cash flow at date t . Note that P y CF P CF PV w t t t t 1 ) 1 ( ) ( + = = T t y CF y CF y CF P ) 1 ( ..... ) 1 ( 1 2 2 1 + + + + + + = RSM 330_Class 12_Summer 2010
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7 8% Bond Time years Coupon  (CF) PV of CF (10%) Weight Time X Weight .5 40 38.095 .0395 .0198 1 40 36.281 .0376 .0376 1.5 2.0 40 1040 sum 34.553 855.611 964.540 .0358 .8871 1.000 .0537 1.7742 1.8853 Duration Calculation 2 year bond, 8% coupon, YTM =10% (semiannual pay) RSM 330_Class 12_Summer 2010
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8 0 200 400 600 800 1000 1200 1 2 3 4 5 6 7 8 Year Cash flow Bond Duration = 5.97 years Example: 8-year, 9% annual coupon bond Properties of Duration FULCRUM = duration What is duration of a zero-coupon bond? • Holding time to maturity constant, when
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This note was uploaded on 07/16/2011 for the course COMMERCE 330 taught by Professor Stapleton during the Fall '10 term at University of Toronto- Toronto.

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Class Note 11_S2010 - RSM 330 Investments Class Note 11 Bond Portfolio Management Maureen Stapleton CFA RSM 330_Class 12_Summer 2010 1 Plan for

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