Portfolio Duration and its Limitations
Like equities, bonds are typically held in a portfolio. Therefore, bond portfolio managers need to measure the whole portfolio duration. There are two methods for calculating the duration of a bond portfolio: the weighted average of time to receipt of…
Money Duration and Price Value of a Basis Point
The modified duration is a measure of the percentage price change of a bond given a change in its yield-to-maturity. On the other hand, the money duration of a bond is a measure of the price change in units of…
Calculate and Interpret Convexity
The Modified Duration provides an estimate of the percentage price change for a bond given a change in its yield-to-maturity. A secondary effect is measured by the convexity statistic. Approximate Convexity The true relationship between the bond price and the…
Duration and Convexity Effect on the Price Change of a Bond
The change in the price of a bond can be summarized as follow: $$\text{Change in price} = \text{Duration effect} + \text{Convexity effect} $$ $$≈(\text{-AnnModDur}×ΔYield)+(\frac{1}{2}×\text{AnnConvexity}×(ΔYield)^2)$$ Example: Change in Price of the Bond when Interest Rate Falls Suppose the yield-to-maturity is expected…
Term Structure of Yield Volatility and Interest Rate Risk
Time horizon is an important aspect of understanding interest rate risk and the return characteristics of a fixed-rate investment. The primary concern for an investor is the change in the price of a bond given a sudden change in its…
Bond’s Holding Period Return, Duration, and Investment Horizon
Although short-term interest rate risk is a concern to some investors, other investors have a long-term horizon. Day-to-day changes in bond prices cause unrealized capital gains and losses. A long-term investor is concerned mostly with the total return over the…
Effect of Credit Spread on Yield-to-maturity
The yield-to-maturity on a corporate bond comprises a government benchmark yield and a spread over that benchmark. The building-blocks approach implies that the yield-to-maturity changes can be broken down further. The benchmark yield could change either because of a change…
Credit Risk in Corporate Bonds
Debt markets play a critical role in the global economy. Companies and governments raise capital in the debt market to fund recurrent expenditures, buy equipment, acquire assets, and so on. As such, bond markets facilitate economic growth. Credit risk is…
Credit Risk – Default Probability and Loss Severity
Credit risk is the risk of loss resulting from a borrower’s failure to make full and timely payments of interest and/or principal. Credit risk is made up of 2 components: default risk or default probability: probability that a borrower will…
Seniority Rankings of Corporate Debt
Capital structure is the composition of a company’s debt and equity, such as bank debt, bonds of all seniority rankings, preferred stock, and common equity. Various debt obligations can have different seniority rankings. This, obviously, implies different priority of payment….
