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Chapter 11 (exam 3)

Chapter 11 (exam 3) - Chapter 11 Chapter Bond Portfolios...

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Unformatted text preview: Chapter 11 Chapter Bond Portfolios Bond Pricing Relationships Bond Inverse relationship between price and yield Long-term bonds tend to be more price Long-term sensitive than short-term bonds sensitive As maturity increases, price sensitivity As increases at a decreasing rate increases Price sensitivity is inversely related to Price coupon rate and YTM coupon Change in Bond Price as a Function of YTM Function Duration Duration Important considerations - Different effects of yield changes on the prices and rates of return for different bonds and - Maturity: iinadequate measure of a bond’s Maturity nadequate economic lifetime economic - A measure is needed that accounts for both size and timing of cash flows size Duration Duration Measure of a bond’s lifetime, stated in years, Measure that accounts for the entire pattern (both size and timing) of cash flows over the life of the bond bond The weighted average maturity of a bond’s The weighted cash flows cash » Weights determined by present value of cash flows present Cash Flows of 8-yr Bond with 9% annual coupon and 10% YTM coupon Calculating Duration Calculating Duration depends on three factors - Maturity of the bond - Coupon payments - Yield to maturity PV(CFt ) D=∑ ×t t =1Market Price n Duration Relationships Duration Duration increases with time to maturity but at a Duration decreasing rate decreasing » For coupon paying bonds, duration is always less than maturity less » For zero coupon-bonds, duration equals time to maturity to Yield to maturity is inversely related to duration is Coupon is inversely related to duration Coupon is Why is Duration Important? Why Allows comparison of Allows effective lives of bonds effective that differ in maturity, coupon that differ Used in bond management strategies Used particularly immunization immunization Measures bond price sensitivity to interest Measures rate movements rate » Directly measures interest rate risk interest Estimating Price Changes Using Duration Using Modified duration: Duration adjusted by the yield Duration to maturity to → D* = D/(1+y) D* D* can be used to calculate the bond’s D* percentage price change for a given change in percentage interest rates interest → ChangeP/P = -D* Changey ChangeP/P Duration Conclusions Duration Price change is proportional to duration, not to Price proportional not maturity maturity To obtain maximum price volatility, iinvestors nvestors To maximum should choose bonds with the longest duration with Duration is additive Duration -Portfolio duration is a weighted average Portfolio weighted Duration measures volatility Duration volatility Duration Example Duration Calculate the duration of a three-year bond that pays a semi-annual coupon of $30, has a $1,000 par value when the YTM is 10%? YTM ...
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