week 4 - much will bond prices change? dP P D (1 y ) dy D *...

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Duration The optimal holding period when income risk and price risk offset one another completely - when interest rate rise >> coupons can be reinvested at a higher rate (gain in reinvestment income) >> but the price of the bond drops due to the higher discount rate (loss in selling price) Weighted average time for an investor to recover the cost of a bond investment Weighted average of the maturities of all CFs paid out by the bond
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Duration Factors affecting Duration 1) Coupon Rate - inversely related to duration 2) Yield - inversely related to duration 3) Time to Maturity - positively related to duration w t CF t /(1 y ) t P 0 D t w t t 1 T
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Duration as a yield sensitivity measure (approximation) How much bond price changes when interest rate changes Modified Duration Eg DQ B, suppose YTM increases from 5% to 5.01%, how
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Unformatted text preview: much will bond prices change? dP P D (1 y ) dy D * D 1 y P P D * y Portfolio Duration The weighted average of the duration of the bonds in the portfolio w PV of bond Total Value of bond portfolio D p w a D a w b D b ... w n D n Immunisation Technique used to insulate interest rate risk Process Set duration of assets equal to the duration of liabilities Set PV of Assets = PV of liability Ensures that both assets and liabilities react equally to interest rate fluctuations at that point in time However, we need to adjust the bond portfolio weights accordingly to keep the portfolio immunised as time to maturity changes >> rebalancing...
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week 4 - much will bond prices change? dP P D (1 y ) dy D *...

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