Term
| 6 properties of Bond Prices |
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Definition
1.Bond Prices and yields are inversely related
2. Increases in Yield to Maturity has a smaller impact than a comparable decrease in yield
3. Long term bonds are more sensitive to changes in yields than short term bonds
4. Sensitivity to changes in yields increases at a decreasing rate as maturity increases
5. High Coupon bonds are less sensitive to changes in yields than low coupon bonds
6. The sensitivity of a bonds price to changes in yield is inversely related to the yield at which it is currently selling |
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Term
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Definition
(Present value of cash flow relative to bond price) D = [(1)*CF1(1+y)^-1 …(n)*CFn(1+y)^-n]/
Bond Price |
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Definition
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Term
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Definition
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Term
| ShortCut Approximation for D* |
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Definition
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Term
| Duration/Modified Duration with Continuous Compounding |
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Definition
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Term
| Modified Duration with semi annual compounding |
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Definition
| Macaulay Duration / (1+ y/2) compound k times a year = (1 + y/k) |
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Term
| Convexity of Bond Annual Compounding |
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Definition
Defined a 2nd Derivative of P, [1/(P*(1+y/k)2) * Σ [ CFt*n*(n+1)/(1+y/k)^n]
Where n is the nth interval (i.e. if semiannual, 1.5 = 3.)
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Term
| Convexity of Bond Continuous Compounding |
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Definition
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Term
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Definition
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Term
| Effective duration and convexity |
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Definition
| Considers that cashflows are not independent of yield - Real impact of change in yield. Useful for bonds with call features, etc. |
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Term
| Example of product with Negative Convexity |
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Definition
| Mortgage Backed Security - prepayment risk increases when interest rates fall |
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Term
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Definition
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Term
Cashflow Matching and Dedication Strategy
2 ads
1 dis
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Definition
Matching - buy a zero coupon bond that will make a payment that exactly matches obligation
Dedication Strategy - combination of coupon paying bonds or zeros to match a series of obligations
advantages:
automatically immunizes the portfolio from changing interest rates
rebalancing will not be necessary
disadvantage -
hard to implement because they impose strong constraints on the bonds that can
be selected.
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