Lecture 7B Aprox Dur.pdf - Analysis of Fixed Income Approx Duration Francis Ng 1 Approximate Duration Convexity \u2022 Modified duration is easily defined

# Lecture 7B Aprox Dur.pdf - Analysis of Fixed Income Approx...

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Analysis of Fixed Income Approx Duration Francis Ng 1 Approximate Duration & Convexity Modified duration is easily defined and computed when cash flow is fixed. What if the cash flows of the bond or security are highly uncertain such as Mortgage Backed Securities (MBS)? How do we measure or compute the duration of the MBS? A practical approach for finding Modified Duration and Convexity is to use the Approximate Duration and Convexity method. 2 Approximate Duration & Convexity We use the Approximation method: Approximate duration = P - - P + 2P 0 ( y) Approximate convexity = P - + P + - 2P 0 P 0 ( y) 2 where P - denotes the price when yield declined by y P + denotes the price when yield increased by y P 0 denotes the initial price y denotes the small yield change 3 Approximate Duration & Convexity  • • • 