4. Bond valuation

Question 1

What is Macaulay duration?

Answer 1

The weighted average term to maturity of the cash flows from a bond. The weighted average time until maturity.

Question 2

What is the modified duration of a bond?

Answer 2

A direct measure of how a bond price varies in response to changes in interest rates or yield to maturity (bond yield). A direct measure of price sensitivity to interest rate changes.

Question 3

What bonds have the same time until maturity and Macaulay duration? Why?

Answer 3

Zero-coupon bonds as there are no coupon payments/multiple payments (only one cash flow), so the weighted average is the same.

Question 4

What is a basis point?

Answer 4

0.01%

Question 5

What is convexity?

Answer 5

A measure of the curvature, or the degree of the curve, in the relationship between bond prices and interest rates. It is introduced into the modified duration formula to more accurately represent the relationship.