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3/14/2014
Interest Rate
Interest Rate Bond Price
1 Bond Price
3/14/2014
IFIM B School
Example
Yield 6% 6.50% 5.50% Price 100 94.4479 106.0195 % Change 5.55% 6.02%
Risk that an investor faces is that the price of a bond will decline if market interest rates rise. This risk referred to as interest rate risk
3/14/2014
IFIM B School
Estimation of % price change for a 100bp is called Duration . So duration is a measure of the price sensitivity of a bond to a change in yield
3/14/2014 IFIM B School 5
3/14/2014
IFIM B School
maturity 2 5 20 30
10
15
20
25
IFIM B School
30
35
7
5.8
3/14/2014
IFIM B School
Risk
When the yield curve shifts, the price of the bond, which was initially priced based on the initial yield curve, will change in price. If the yield curve flattens, then the yield spread between long- and short-term interest rates narrows, and the price of the bond will change accordingly. If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. Therefore, long-term bond prices will decrease relative to short-term bonds.
3/14/2014
IFIM B School