Further Questions

General info on bond pricing

Note that there are lots of little practical details in bond pricing that the book
skips like the difference between the clean and dirty bond price, different day
count conventions (30/360, Actual/360, Actual/Actual) etc. These details are
important because you get accrued interest when you sell a bond as opposed
to a stock were you do not get accrued dividends. The accrued interest goes
to the seller of the bond, the price that includes accrued interest is called the
dirty price, the quoted price at e.g. Bloomberg or Trace is the clean price. You
need the dirty price to calculate bond returns. We will look more at this in
the Python notebook. These details also mean that you may not get the exact
same answers if you use the built-in Python functions for Bond pricing as in the
book.

Q 14.15
Pn vi
a) Equation 9.1 States D = − B1 ∆B


∆y and 9.3 states D = i=1 ti B , we know
Pn Pn
B = i=1 CFi e−yti so ∂Y∂B
= − i=1 ti CFi e−yti plug the derivate into 9.1 and
we get
  n
! n
1 ∆B 1 X
−yti
X v 
i
D=− = − − ti CFi e = ti
B ∆y B i=1 i=1
B

the last equality follows from the definition of vi = CFi e−yti .

Q 14.17
a) For zero coupon bondsPnthe duration is equal to the maturity of the bond, you
can see this from D = i=1 ti vBi since vi = 0 ∀ i < n and vi = B for i = n. So


2000e−0.1 6000e−0.1·10
the duration of Portfolio A is 2000e−0.1 +6000e−0.1·10 ·1+ 2000e−0.1 +6000e−0.1·10 ·10 =
5. 95 years which is also the duration of portfolio B.
b) Value before change for portfolio A is 2000e−0.1 + 6000e−0.1·10 = 4017.
0 and for B 5000e−0.1·5.95 = 2757. 8. Value after change for A is 2000e−0.101 +
6000e−0.101·10 = 3993. 2 and a precentage change of 3993.2−4017 4017 = −0.5 92%.
Value after change for B is 5000e−0.101·5.95 = 2741. 5 and the percentage change
is 2741.5−2757.8
2757.8 = −0.5 91% .(Change is not exactly same in A and B because of
round off error and to some degree different convexity).
c) Value after change for A is 2000e−0.15 + 6000e−0.15·10 = 3060. 2 and a pre-
centage change of 3060.2−4017
4017 = −23.8 Value after change for B is 5000e−0.15·5.95 =
2048. 2 and the percentage change is 2048.2757.8
2−2757.8
= −25.7% . The take away
here is that duration is not a good risk measure for large changes (it is similar
to delta), portfolio B has larger convexity and therefore changes more in value
than portfolio A.

1
Q 14.19
See Python Notebook.