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Chapter 17 Bonds-Analysis And Management

Chapter 17 Bonds-Analysis And Management. Bond Pricing Principles. Bond Prices and the Passage of Time Bond Prices and Changes in Yield to Maturity Bond Price Sensitivity and Maturity Changes in Bond Price Sensitivity and Changes in Time to Maturity for Various Maturities

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Chapter 17 Bonds-Analysis And Management

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  1. Chapter 17Bonds-Analysis And Management

  2. Bond Pricing Principles • Bond Prices and the Passage of Time • Bond Prices and Changes in Yield to Maturity • Bond Price Sensitivity and Maturity • Changes in Bond Price Sensitivity and Changes in Time to Maturity for Various Maturities • Bond Price and Coupon

  3. Bond Prices And The Passage Of Time • Price and Value Change with the Passage of Time • Premium • Par • Discount

  4. Bond Prices And Changes In Yield To Maturity • Prices are Inversely Related to Yield to Maturity • Price-Yield Relationship is Convex

  5. Bond Price Sensitivity And Maturity • Different for Various Bond Maturities • The Longer the Maturity • The more sensitive the bond’s price to change in the yield to maturity

  6. Does a 1-year or 10-year 10% bond have more interest rate (or price) risk? Interest rate risk: Rising kd causes bond’s price to fall. kd 1-year Change 10-year Change 5% $1,048 $1,386 +4.8% -4.4% +38.6% -25.1% 10% 1,000 1,000 15% 956 749

  7. Value 10-year . 1,500 . . . . 1-year 1,000 . 500 kd 0 0% 5% 10% 15%

  8. Changes In Bond Price Sensitivity And Changes In Time To Maturity For Various Maturities • Increases at a Decreasing Rate • With the length to maturity • 5 and 10-Year Bond • 25 and 30-Year Bond

  9. Bond Value ($) kd = 7%. 1,372 1,211 kd = 10%. M 1,000 837 kd = 13%. 775 30 25 20 15 10 5 0 Years remaining to Maturity

  10. Bond Price And Coupon • Linear Relationship • Drift Towards Par Value • With just the passage of time • The Higher the Coupon Rate • The less sensitive the bond to changes in yield to maturity

  11. Is There A Way To Reduce Or Eliminate The Interest-Rate Risk? • Duration • Holding period • Price effect • Reinvestment effect • Calculating duration next slide • Measures the sensitivity • Used by investment analysts

  12. Calculating Duration T D =  tWt t = 1

  13. Duration Principles • Duration • Declines over time • Inversely related to yield to maturity • Directly related to maturity • Inversely related to level of coupon payment • Bond portfolio • More Than One Factor • Relationship becomes more complex

  14. How Do You Measure The Curvature Of A Bond’s Price-Yield Relationship? • Convexity • Basic principles • Inversely related to yield to maturity • Inversely related to the coupon • Positively related to duration

  15. Income Immunization Price

  16. Income Immunization • Strategies • Cash matching • Duration matching • Horizon matching • Protects Future Income Needs • Ignores Current Market Value

  17. Price Immunization • Protects Current Market Value • Uses Convexity • The Greater the Convexity • The greater the gain from changes in interest rates

  18. Passive Bond Management • Mimic a Bond Index • Is the Bond Market Efficient? • Yes Passive management • No Active management • Refining Immunization Techniques

  19. Active Bond Management • Contingent Immunization • Timing strategies • Duration mismatches • Floor on active manager’s performance • Popular Active Bond Management Strategies • Substitution swap • Pure Yield pickup swap • Intermarket spread swap • Rate anticipation swap

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