interest rate risk management

Question 1

what is the value of a bond equal to?

Answer 1

pv of coupons + pv of face value

Question 2

what does the yield indicate?

Answer 2

annual return until the bond matures

Question 3

what is the interest rate risk?

Answer 3

probability of a decline in the value of an asset (fixed-income investment) as a result of unexpected fluctuations in interest rates

Question 4

are risk free bonds exposed to interest rate risk?

Answer 4

yes

Question 5

what is the main risk resulting from changes in interest rates?

Answer 5

price risk, if the interest rate increases, the price risk increases (price of bond decreases)

Question 6

besides price risk, what is the risk resulting from changes in interest rates?

Answer 6

reinvestment risk, if the YTM increases, reinvestment risk decreases (less likelihood to be paid back before maturity)

Question 7

Holding all other features equal, are longer maturity bonds more or less convex?

Answer 7

more

Question 8

What happens to the bond prices (PV) when the interest rate increases?

Answer 8

they decrease

Question 9

What happens to the bond prices (PV) when the interest rate decreases?

Answer 9

they increase

Question 10

are longer-term bonds more or less sensitive to interest rate risk?

Answer 10

more

Question 11

are lower-coupon bonds more or less sensitive to interest rate risk?

Answer 11

more

Question 12

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.

Answer 12

true

Question 13

true or false: price sensitivity with respect to YTM variations increases with maturity at a decreasing rate

Answer 13

true

Question 14

are bond prices more sensitive to YTM variations when the bond is sold at a lower initial YTM?

Answer 14

yes

Question 15

are bond prices more sensitive to YTM variations when the bond is sold at a higher initial YTM?

Answer 15

no

Question 16

what does the duration of a bond measure?

Answer 16

the sensitivity of the bond’s full price (including accrued interest) to changes in interest rates

Question 17

what is the macauly duration?

Answer 17

a weighted average of the time to receipt og the bond’s promised cash flows (coupons and face value)

Question 18

why is modified duration important?

Answer 18

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

Question 19

how can the percentage variation of a bond’s price caused by the variation in YTM be estimated?

Answer 19

by multiplying the modified duration by the YTM’s variation

Question 20

what is the dollar duration of a bond?

Answer 20

a measure of the price change in units of the currency in which the bond is denominated

Question 21

how is the dollar duration calculated?

Answer 21

annual modified duration times the full price of the bond (including accrued interest)

Question 22

what is the PVBP (price value of a basis point)?

Answer 22

an estimate of the change in the full price given a 1bp change in the YTM

Question 23

what are the benefits of duration?

Answer 23

easy to compute
easy to understand
quite acceptable and reasonable in many circumstances (small move in YTM)

Question 24

what are the drawbacks of duration?

Answer 24

acceptable only with bonds generating fixed cash flows (doesn’t work with bonds with embedded options)
supposes parallel moves in the yield curve

Question 25

what is portfolio duration?

Answer 25

weighted sum of individual durations

Question 26

when the YTM decreases, what happens to the duration of a coupon bond?

Answer 26

increases

Question 27

when the YTM increases, what happens to the duration of a coupon bond?

Answer 27

decreases

Question 28

for a given maturity, what happens to duration when the coupon rate decreases?

Answer 28

increases

Question 29

for a given maturity, what happens to duration when the coupon rate increases?

Answer 29

decreases

Question 30

for a given coupon rate, does duration generally increase with maturity?

Answer 30

yes

Question 31

when does duration always increase with maturity?

Answer 31

bonds sold at par or at a premium

Question 32

what is the duration of a zero-coupon bond?

Answer 32

time to maturity

Question 33

what is the duration of a perpetuity?

Answer 33

(1 + y) / y

Question 34

true or false: the relation ship between bond prices and YTM is convex.

Answer 34

true