MODIFIED DURATION

DEF: APPROX CHANGE IN BOND PRIE FOR A UNIT CHANGE IN YIELD

( P- - P+ )
MOD DUR =
2*(YLD CHG)*Po

ASSUME YLD CHANGE OF 25 BPS FOR COMPUTING P- & P+

% CHANGE IN BOND PRICE = -D% * (YLD CHG*) * 100

REVISED BOND PRICE = Po *(1 + % CHG IN BP)

BOND WITH 8% COUPON AND 5 YEARS MATURITY HAS A YTM OF 9%.

FIND MODIFIED DURATION
Po P+ P-
COUPON 8 8 8
MATURITY 5 5 5
FACE VALUE 100 100 100 YIELD CHANGE ASSUMED TO BE 25 BPS
YTM 9% 9.25% 8.75%
PRICE ₹ 96.11 ₹ 95.17 ₹ 97.06
=-PV(D19,D17,D16,D18) % CHANGE IN BOND PRICE = -D% * (YLD CHG*) *
MOD DUR 3.94 REVISED BOND PRICE = Po *(1 + % CHG IN BP)
=(F20-E20)/(2*0.25%*D20)

YIELD HAS INCREASED BY 17 BPS. WHAT IS THE NEW PRICE OF BOND??

YIELD HAS DECREASED BY 77 BPS. WHAT IS THE NEW PRICE
% CHG IN BP = -0.67% =-C22%*0.17%*100 % CHG IN BP = 3.04%
REVISED PRICE = 95.47 =D20*(1+D27) REVISED PRICE = 99.03

FULL VALUATION PRICE EST. =

99.09

COVEXITY ADJ 20.57

CONVEXITY ( P- + P+ - 2*Po) % CHG IN BP = 3.10%
ADJUSTMENT = (YLD CHG)^2*Po REVISED PRICE = 99.09

% CHANGE IN BOND PRICE = -D%*(YC*)*100 + 1/2*C%*(YC*)^2*100

REVISED BOND PRICE = Po *(1 + % CHG IN BP)
MED TO BE 25 BPS

PRICE = -D% * (YLD CHG*) * 100

E = Po *(1 + % CHG IN BP)

PS. WHAT IS THE NEW PRICE?

=-C22%*-0.77%*100
=D20*(1+J27)

=-PV(8.23%,5,8,100)

=(E20+F20-2*D20)/(0.25%^2*D20)
=-C22%*-0.77%*100+1/2*J33%*-0.77%^2*100
=D20*(1+J34)
Duration Questions

Q1
Find Duration and Convexity for a 7% coupon bond with 5 years maturity and Face Value = 100 using 50 bps change in yield

% change in bond price using duration convexity approach if yield increases by 110 bps
Price the same bond usin the full valuation approach and note the value

Q2
Find Duration and Convexity for a 12% coupon bond with 6 years maturity and Face Value = 100 using 50 bps change in yield

% change in the bond price for 95 bps derease in yield

Price the same bond usin the full valuation approach and note the value

Understanding Key Rate Duration

Q3
For the Zero coupon bonds in our portfolio
Using Portfolio Duration Approach for Parallel Yield Curve Shift - Find the revised value of portfolio
Investment Face Modified
Bonds Maturity Yield Weights Rate Duration
amount Value Duration
1 5 1000 1500 8.45% 4.61 27.03% 1.25
2 10 1200 2000 5.24% 9.50 32.43% 3.08
3 15 1500 2750 4.12% 14.41 40.54% 5.84
Total Portfolio value 3700 10.17
% change in portfolio value = -2.54%
What will be the portfolio value if the yield curve goes up by 25 bps parallel
3,606 =C24*(1+H25)

Q4 Using Portfolio Duration Approach for Non-Parallel Yield Curve Change

Investor holds following zero coupon bond portfolio
Annual pay bonds Non Parallel =-PV(D33,C33,0,

Bonds Par Value Maturity Yield Yield Curve change Price

1 1000 5 6% 50 bps 747
2 2000 10 7% 35 bps 1,017
3 3000 15 9% 20 bps 824
4 4000 20 11% 5 bps 496

What is the portfolio value today 3,084

% change in portfolio value for the non parallel yield curve change

Q5 Using Portfolio Duration Approach for Parallel Yield Curve Shift

Investor holds following zero coupon bond portfolio
Annual pay bonds Non Parallel
 Bonds Par Value Maturity Yield Yield Curve change Price
1 2000 5 6% -50 bps 1,495
2 2000 10 7% -20 bps 1,017
3 4000 15 8% +15 bps 1,261
4 5000 20 9% +20 bps 892

What is the portfolio value today 4,664

% change in portfolio value for the non parallel yield curve change

Q6 Valation of Portfolio Duration-Convexity Approach =-C56%*F56*100+1/2*D56%*F56^

Number of Yield % Change in

Price Duration Convexity Yield (inc/Dec)
bonds change Bond Price

Bond-1 95 5 10 100 1.50% inc -7.39%

Bond-2 86 10 25 200 0.55% inc -5.46%
Bond-3 102 15 40 150 -0.50% dec 7.55%
Bond-4 108 20 60 125 -1.00% dec 20.30%

What is the portfolio value today 55500

% change in portfolio value for the non parallel yield curve change
0 using 50 bps change in yield

00 using 50 bps change in yield

=H33/$H$38 =C33/(1+D33) =I33*J33 NON PARALLEL

ModifiedRate % Price
Weights Duration
Duration Change in YC Impact
24.23% 4.721.14 0.50% -0.57%
32.97% 9.353.08 0.35% -1.08%
26.71% 13.76 3.68 0.20% -0.74%
16.09% 18.02 2.90 0.05% -0.14%
10.80 -2.53%
=SUM(M33:M36)
YC UNDERGOES PARALLEL DECREASE BY 33 BPS 3,006
% CHG IN PORT VAL = 3.56% =H38*(1+M37)
=-K37%*-0.33%*100
3,194 =H38*(1+K40)
 Modified Rate % Price
Weights Duration Duration Change in YC Impact
32.04% 4.72 1.51 -0.50% 0.76%
21.80% 9.35 2.04 -0.20% 0.41%
27.03% 13.89 3.75 0.15% -0.56%
19.13% 18.35 3.51 0.20% -0.70%
-0.10% 3%

4,660

6%*F56*100+1/2*D56%*F56^2*100

Revised Bond
Price

87.98 =B56*(1+H56)
81.30
109.70
129.92

57,754 =SUMPRODUCT(E56:E59,I56:I59)
 1% 2% 3%
year 5 10 15
RD 3 4 5 12
W1 * D1 W2 * D2 W3 * D3 Pd

PORTFOLIO VALUE = 100

MACAULAY DURATION

DEF.: TIME IN WHICH YOU RECEIVE THE PRESENT VALUE OF CASH FLOWS BACK

10%, COUPON BOND, WITH MATURITY 5 YEARS AND YIELD 11%

FIND MAC DURATION
PRICE ₹ 96.30 =-PV(11%,5,10,100)
=C10/(1+11%)^B10
CASH PV OF CF *
YEARS PV OF CF MOD DUR = MAC DUR / (1
FLOW TIME
1 10 9.01 9.01 =D10*B10 K = ADJUSTMENT FOR COUPON
2 10 8.12 16.23
3 10 7.31 21.94
4 10 6.59 26.35 MAC DUR =
5 110 65.28 326.40
96.30 399.92
MAC DUR 4.15 YEARS
=E15/D15
MOD DUR 3.74 =E16/(1+11%)

10% 5 year par bond. YTM = 10%

1 2 3 4 5 1 2
10 10 10 10 110 10 10
REINV RATE 9% 8% 7% 8% 9% 9% 8%
REINV PRD 1 0 4 3
10.9 10 14.12 12.60
₹ 105.15 ₹ 126.05
12.27% > YTM
INTEREST RATE RISK IN FAVOR

1 2 3 4 5 1 2
10 10 10 10 110 10 10
REINV RATE 11% 12% 13% 12% 11% 11% 12%
REINV PRD 1 0 4 3
11.1 10 15.18 14.05
₹ 95.20 ₹ 116.30
7.84% < YTM
INTEREST RATE RISK AGAINST

8% COUPON BOND WITH YTM = 10%, MATURITY 5 YERS, PAR VALE = 100 5 YEAR , 10% YTM ZCB
MAC DURATION? FIND MAC DUR

CASH PV OF CF * CASH
YEARS PV OF CF YEARS
FLOW TIME FLOW
1 8 ₹ 7.27 ₹ 7.27 1 0
2 8 ₹ 6.61 ₹ 13.22 2 0
3 8 ₹ 6.01 ₹ 18.03 3 0
4 8 ₹ 5.46 ₹ 21.86 4 0
5 108 ₹ 67.06 ₹ 335.30 5 100
₹ 92.42 ₹ 395.68
YEARS MAC DUR 4.28 =E53/D53 YEARS
% MOD DUR 3.89 =E54/(1+10%) %

7% COUPON BOND (SEMI ANNUAL), 3 YEARS MATURITY, YTM = 9%

MAC DUR/MOD DUR?

SEMI CASH PV OF CF *
PV OF CF
ANNUAL FLOW TIME
1 3.5 ₹ 3.35 ₹ 3.35
2 3.5 ₹ 3.21 ₹ 6.41
3 3.5 ₹ 3.07 ₹ 9.20
4 3.5 ₹ 2.93 ₹ 11.74
5 3.5 ₹ 2.81 ₹ 14.04
6 103.5 ₹ 79.48 ₹ 476.86
₹ 94.84 ₹ 521.61
MAC DUR 2.75 YEARS =E67/D67/2
MOD DUR 2.63 % =E68/(1+9%/2)
 MOD DUR = MAC DUR / (1 + YTM/K)

K = ADJUSTMENT FOR COUPON FREQ

MAC DUR = ∑ PV OF CASH FLOW * TIME

∑ PV OF CASH FLOW

3 4 5 1 2 3 4
10 10 110 10 10 10 10
7% 8% 9% REINV RAT 9% 8% 7% 8%
2 1 0 REINV PRD 2 1 0
11.45 10.80 110.00 11.881 10.8 10
158.96 ₹ 105.42
9.71% < YTM ₹ 138.11
RE-INVESTMENT RISK WENT AGAINST 11.36%

3 4 5
10 10 110
13% 12% 11%
2 1 0
12.77 11.20 110.00
163.20
10.29% > YTM
RE-INVESTMENT RISK IN FAVOR

0% YTM ZCB
 PV OF CF *
PV OF CF
TIME
₹ 0.00 ₹ 0.00
₹ 0.00 ₹ 0.00
₹ 0.00 ₹ 0.00
₹ 0.00 ₹ 0.00
₹ 62.09 ₹ 310.46
₹ 62.09 ₹ 310.46
MAC DUR 5.00
MOD DUR 4.55
 5
110
9%
BOND PORTFOLIO IMMUNISATION
match your liability maturity with a portfolio whse mac dur = maturity of liability

LIABILITY 1,000,000 AFTER 2 YEARS

investment 881,659 <== assets =B4/(1+B9)^2

MAUTIRY YTM
1 6.0%
2 6.5% <== Re-investment risk
3 7.0%
bond-1 (zcb) bond-2
maturity 1 3 YEARS CF PV OF CF
coupon 0% 7% 1 7 6.54
fv 100 100 2 7 6.11
ytm 6.0% 7.0% 3 107 87.34
PRICE 94.34 100.00 100.00
MAC DUR 1 2.81 MAC DUR
WEIGHTS 44.7% 55.3%
INVEST AMOUNT 394,021 487,639
UNITS 4,177 4,876

B-1 @ Y-1 417,662 C-1 @ Y-1 34,135 1 YR T-BILL RATE AFTER 1 YR

B-1 @ Y-2 442,722 C-1 @ Y-2 36,183 1 YR T-BILL RATE AFTER 2 YR
C-2@Y-2 34,135
P2 ₹ 99.07 PORT VALUE @ 2 YR
483,123 SURPLUS/(DEFICIT)

REBALANCING REQUIRED
 PV OF CF * TIME
6.54
12.23
262.03
280.80
2.81

6%
8%

996,163
-3,837

CING REQUIRED
Questions on Portfolio Duration
Portfolio manager feels that interest rates will change over the next year but is uncertain about the extent and
direction of this change. He is confident, however, that the yield curve will change in a nonparallel manner and
that duration will not accurately measure the overall total portfolio's yield-curve risk exposure. To help him
evaluate the risk of his client's total portfolio, he has assembled the table of rate durations shown below.

Value
Issue 3 mo 2 yr 5 yr 10 yr 15 yr 20 yr 25 yr
($millions)
Portfolio 1 100 0.03 0.14 0.49 1.35 1.71 1.59 1.47
Portfolio 2 200 0.02 0.13 1.47 0 0 0 0
Portfolio 3 150 0.03 0.14 0.51 1.4 1.78 1.64 2.34
Portfolio 4 250 0.06 0 0 0 0 0 0
Portfolio 5 300 0 0.88 0 0 1.83 0 0
1000 0.03 0.33 0.42 0.35 0.99 0.41 0.50

Q1
The value of the total portfolio is $1,000,000,000.
If the following three key rates change while the others remain constant: 3M
§ The 3-month rate increases by 20 basis points. YLD CHG 0.20%
§ The 5-year rate increases by 90 basis points. KRD 0.03
§ The 30-year rate decreases by 150 basis points. % PRICE CHANGE -0.01%
What will be the new portfolio Value? =-I20%*I19*100

Q2
If the original yield curve undergoes a parallel shift such that the rates
at all key maturities increase by 50 basis points. % CHANGE IN BOND PORTFOLIO =
What will be the new portfolio Value? REVISED PORTFOLIO VALUR =

Q3
If the original yield curve undergoes a shift such that 3-month rates remain constant
and all other rates increase by 135 basis points. The new value of portfolio 4 will be?
REMAINS SAME
Q4
The 10-year key rate duration for the total portfolio is?
0.35
Q5
The PORTFOLIO duration for Portfolio 2 is?
1.62
Q6
Which of the portfolios are examples of
a.) Laddered portfolio 1, 3
b.) Barbell Portfolio 5
c.) Bullet Portfolio 2, 4
out the extent and
arallel manner and
re. To help him
hown below.

PORTFOLIO = EFFECTIVE DURATION

30 yr
WEIGHTS
4.62 10% 11.4
0 20% 1.62
2.83 15% 10.67
0 25% 0.06
0 30% 2.71
0.89 3.89

5Y 30Y
0.90% -1.50%
0.42 0.89 =SUM(I21:K21)
-0.38% 1.33% 0.95%
-I20%*I19*100 1009.469
=B14*(1+L21)

-1.95% =-L14%*0.5%*100
980.5375 =B14*(1+J26)
 Value
($million 3 mo 2 yr 5 yr 10 yr 15 yr 20 yr 25 yr 30 yr
s) PORT = EFF DUR
100 0.03 0.14 0.49 1.35 1.71 1.59 1.47 4.62 0.333333
200 0.02 0.13 1.47 0 0 0 0 0 0.666667
300 0.02 0.13 1.14 0.45 0.57 0.53 0.49 1.54
PORT = EFF DUR

4.88
Exercise on Portfolio Duration

Value in
$Mn 3 Months 2 5 10 15 20 25 30
Bond-1 300 0.03 0.14 0.49 1.35 1.71 1.59 1.47 4.62
Bond-2 200 0.02 0.13 1.47 0.00 0.00 0.00 0.00 0.00
Bond-3 500 0.03 0.14 0.51 1.40 1.78 1.64 2.34 2.83
Bond-4 250 0.06 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Bond-5 300 0.00 0.88 0.00 0.00 1.83 0.00 0.00 0.00

Q1 What is the 5 –yr, 15yr and 25 yr key rate duration for the portfolio?
Q2 What is the effective duration of the bond-3?
Q3 What is the 30 year rate duration of bond-1?
Q4 What will be the portoflio value if the 3Month rate goes up by 65bps, 15 year rate goes up by 15bps and 25 year ra
Q5 What will be the portoflio value if the 2 year rate goes up down 25 bps, 10 year rate goes up down 35 bps , 25 year
Q6 What will be the value of the portfolio if the yield curve witnesses a parallel downward shift of 35 bps
Q7 What will be the value of the portfolio if the yield curve witnesses a parallel upward shift of 72 bps
 up by 15bps and 25 year rate goes down by 25 bps
es up down 35 bps , 25 year rate goes down by 25 bps and 30 year rate goes up by 5 bps
shift of 35 bps
ft of 72 bps