Not To Be Naïve about Duration

Slides:

Advertisements

Similar presentations

Bond pricing theorems. Bond convexity The mathematical relationship between bond yields and prices.

Advertisements

Contents Method 1: –Pricing bond from its yield to maturity –Calculating yield from bond price Method 2: –Pricing bond from Duration –Pricing bond from.

Bond Price Volatility.

6-1 Chapter 6 The Risk of Changing Interest Rates.

CHAPTER 4 BOND PRICES, BOND YIELDS, AND INTEREST RATE RISK.

Bond Yields Fixed Income Securities. Outline Sources of Return for a Bond Investor Measures of Return/Yield Nominal Yield Current Yield Yield to Maturity.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Managing Bond Portfolios CHAPTER 11.

Interest-Rate Risk II. Duration Rules Rule 1: Zero Coupon Bonds What is the duration of a zero-coupon bond? Cash is received at one time t=maturity weight.

More on Duration & Convexity

Duration and Portfolio Immunization. Portfolio Immunization Portfolio immunization –An investment strategy that tries to protect the expected yield from.

The basics of bond immunization Objective Explain the concept of immunization and understand how it relates to bond portfolio management.

1 Applying Duration A Bond Hedging Example Global Financial Management Fuqua School of Business Duke University October 1998.

Copyright © 2009 Pearson Prentice Hall. All rights reserved. 3-1 Distinction Between Real and Nominal Interest Rates Real interest rate 1.Interest rate.

Chapter 11 Bond Yields and Prices. Learning Objectives Calculate the price of a bond. Explain the bond valuation process. Calculate major bond yield measures,

Method 3: Pricing of Coupon Bond Pricing of coupon bond without knowing the yield to maturity.

Managing Bond Portfolios

Bonds Valuation PERTEMUAN Bond Valuation Objectives for this session : –1.Introduce the main categories of bonds –2.Understand bond valuation –3.Analyse.

Managing Bond Portfolios

Managing Bond Portfolios

TERM STRUCTURE OF INTEREST RATES (also called YIELD CURVE) A PLOT OF YIELD TO MATURITY VS. MATURITY.

Yields & Prices: Continued

Fixed-Income Portfolio Management b Strategies Risk ManagementRisk Management Trade on interest rate predictionsTrade on interest rate predictions Trade.

FINC4101 Investment Analysis

Managing Bond Portfolios

BOND PRICES AND INTEREST RATE RISK

Managing Bond Portfolio

Valuing risky debt The story teller makes no choice, soon you will not hear his voice. His job is to shed light and not to master. – Garcia, Hunter.

Duration and Convexity

CHAPTER 5 BOND PRICES AND RISKS. Copyright© 2003 John Wiley and Sons, Inc. Time Value of Money A dollar today is worth more than a dollar in the future.

Chapter 8 Jones, Investments: Analysis and Management

1 Debt Valuation Topic #2. 2 Context Complete Markets Bonds  Time Value of Money  Bond Valuation Equity Derivatives Real Estate.

Chapter 5 part 2 FIN Dr. Hisham Abdelbaki FIN 221 Chapter 5 Part 2.

CHAPTER ELEVEN Bond Yields and Prices CHAPTER ELEVEN Bond Yields and Prices Cleary / Jones Investments: Analysis and Management.

Comm W. Suo Slide 1. comm W. Suo Slide 2 Managing interest rate risk  Bond price risk  Coupon reinvestment rate risk  Matching maturities.

Problems Consider the following Bond Structure Face ValueInterest Rate (%) Maturity (Years) Current Price

CHAPTER 5 BOND PRICES AND INTEREST RATE RISK. Copyright© 2006 John Wiley & Sons, Inc.2 The Time Value of Money: Investing—in financial assets or in real.

Copyright © 2000 by Harcourt, Inc. All rights reserved Chapter 16 Interest Rate Risk Measurements and Immunization Using Duration.

Chapter 11 Managing Bond Portfolios. Interest Rate Sensitivity (Duration we will cover in Finc420) The concept: Any security that gives an investor more.

1 Not To Be Naïve about Duration 1.The duration D we have been discussing also known as Macaulay duration. 2.First derivative of price-yield curve is and.

Comm W. Suo Slide 1. comm W. Suo Slide 2  Active strategy Trade on interest rate predictions Trade on market inefficiencies  Passive.

Bond Price Volatility Chapter 4.

Fixed Income Kuliah 8.

Class Business Upcoming Homework. Duration A measure of the effective maturity of a bond The weighted average of the times (periods) until each payment.

Bond Price Volatility. Price Yield Relationship Recall the earlier discussion… –Inverse relationship between Price and Yield Price Yield.

1 Convexity Correction Straight line is what we get with %ΔPB formula (under- estimates when yield drops, over-estimates when rises) Greater a bond’s convexity,

Chapter 11 Managing Bond Portfolios 1. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Interest Rate Risk A change in market.

Liability Funding Strategies. Asset Liability Management Types of Liabilities of Institutional Investors –Amount Known, Time Known (GIC) –Amount Known,

Computational Finance 1/37 Panos Parpas Bonds and Their Valuation 381 Computational Finance Imperial College London.

Managing Bond Portfolios

Analysis and Management of Bond

Interest Rate Futures Chapter 6

Managing Bond Portfolios

Taylor Expansion To measure the price response to a small change in risk factor we use the Taylor expansion. Initial value y0, new value y1, change y:

Financial Risk Management of Insurance Enterprises

Interest Rates Chapter 4 (part 2)

CHAPTER 5 BOND PRICES AND RISKS.

Exam FM/2 Review Cash Flows, portfolios, duration, & immunization

BOND PRICES AND INTEREST RATE RISK

Managing Bond Portfolios

Fuqua School of Business Duke University

Interest Rate Forwards and Futures

Fundamentals of Investments

Bonds, Bond Prices, Interest Rates and Holding Period Return

Not To Be Naïve about Duration

Managing Bond Portfolios

V: Bonds 15: Duration.

Bonds and Their Valuation Supplement

Fixed Income Securities and Debt Markets

IV. Fixed-Income Securities

Presentation transcript:

Not To Be Naïve about Duration The duration D we have been discussing also known as Macaulay duration. First derivative of price-yield curve is and is known as modified duration. Found in %ΔPB formula. Convexity is second derivative of price-yield curve. Is a complicated expression (not studied here). 10/27

Managing Interest Rate Risk (a) Duration is the holding period for which reinvestment risk exactly offsets price risk. Designed to give investor the YTM that was in effect at time bond purchased. A way duration is used: If have a $5 million liability 7.5 years from now, buy a bond (or a portfolio of bonds) today that has a duration of 7.5 years. Then sell at the 7.5 year mark. 10/31

Example 18: Rebalancing Bond Portfolio Consider the $20,000 portfolio ($4,000 in D = 5, $10,000 in D = 7, $6,000 in D = 9) of Example 17. How much in D = 9 bonds should be sold, and how much in D = 5 bonds should be purchased, to reduce Portfolio D to 6.80?

Eliminating Interest Rate Risk (b) Zero-coupon approach (best way). Buy high quality “zeros” with maturity equal to desired holding period. Locks in YTM. No reinvestment risk because no coupons payments, no price risk when held to maturity. Duration matching (next best way). Selecting a portfolio of bonds whose duration matches desired holding period. Theoretically perfect, but only approximately perfect in real world as per footnote 8 on p. 162. Maturity matching (don’t use). That is, selecting bonds with terms to maturity equal to desired holding period. Don’t use. Doesn’t work for eliminating interest rate risk.