interest rate risk management Flashcards
what is the value of a bond equal to?
pv of coupons + pv of face value
what does the yield indicate?
annual return until the bond matures
what is the interest rate risk?
probability of a decline in the value of an asset (fixed-income investment) as a result of unexpected fluctuations in interest rates
are risk free bonds exposed to interest rate risk?
yes
what is the main risk resulting from changes in interest rates?
price risk, if the interest rate increases, the price risk increases (price of bond decreases)
besides price risk, what is the risk resulting from changes in interest rates?
reinvestment risk, if the YTM increases, reinvestment risk decreases (less likelihood to be paid back before maturity)
Holding all other features equal, are longer maturity bonds more or less convex?
more
What happens to the bond prices (PV) when the interest rate increases?
they decrease
What happens to the bond prices (PV) when the interest rate decreases?
they increase
are longer-term bonds more or less sensitive to interest rate risk?
more
are lower-coupon bonds more or less sensitive to interest rate risk?
more
true or false: an increase in the ytm leads to a smaller price decrease than the price increase caused by a decrease in YTM of the same importance.
true
true or false: price sensitivity with respect to YTM variations increases with maturity at a decreasing rate
true
are bond prices more sensitive to YTM variations when the bond is sold at a lower initial YTM?
yes
are bond prices more sensitive to YTM variations when the bond is sold at a higher initial YTM?
no
what does the duration of a bond measure?
the sensitivity of the bond’s full price (including accrued interest) to changes in interest rates
what is the macauly duration?
a weighted average of the time to receipt og the bond’s promised cash flows (coupons and face value)
why is modified duration important?
modified duration measures the first-order effect of yield variation, it provides a linear (approximate) of the percentage price change for a bond given a change in its YTM
how can the percentage variation of a bond’s price caused by the variation in YTM be estimated?
by multiplying the modified duration by the YTM’s variation
what is the dollar duration of a bond?
a measure of the price change in units of the currency in which the bond is denominated
how is the dollar duration calculated?
annual modified duration times the full price of the bond (including accrued interest)
what is the PVBP (price value of a basis point)?
an estimate of the change in the full price given a 1bp change in the YTM
what are the benefits of duration?
easy to compute
easy to understand
quite acceptable and reasonable in many circumstances (small move in YTM)
what are the drawbacks of duration?
acceptable only with bonds generating fixed cash flows (doesn’t work with bonds with embedded options)
supposes parallel moves in the yield curve
what is portfolio duration?
weighted sum of individual durations
when the YTM decreases, what happens to the duration of a coupon bond?
increases
when the YTM increases, what happens to the duration of a coupon bond?
decreases
for a given maturity, what happens to duration when the coupon rate decreases?
increases
for a given maturity, what happens to duration when the coupon rate increases?
decreases
for a given coupon rate, does duration generally increase with maturity?
yes
when does duration always increase with maturity?
bonds sold at par or at a premium
what is the duration of a zero-coupon bond?
time to maturity
what is the duration of a perpetuity?
(1 + y) / y
true or false: the relation ship between bond prices and YTM is convex.
true
