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Chapter 4

**Price Volatility Characteristics
**

Exhibit 4-3. Instantaneous Percentage Price Change for 6 Hypothetical Bonds

Six hypothetical bonds, priced initially to yield 9%:

9% coupon, 5 years to maturity, price = $100.0000

9% coupon, 25 years to maturity, price = 100.0000

6% coupon, 5 years to maturity, price = 88.1309

6% coupon, 25 years to maturity, price = 70.3570

0% coupon, 5 years to maturity, price = 64.3928

0% coupon, 25 years to maturity, price = 11.0710

Yield Change

to:

6

7

8

8.5

8.9

8.99

9.01

9.1

9.5

10

11

12

Change

Percentage Price Change (coupon/maturity in years)

in BP

9%/5

9%/25

6%/5

6%/25

0%/5

0%/25

–300

12.8

38.59

13.47

42.13

15.56

106.04

–200

8.32

23.46

8.75

25.46

10.09

61.73

–100

4.06

10.74

4.26

11.6

4.91

27.1

–50

2

5.15

2.11

5.55

2.42

12.72

–10

0.4

1

0.42

1.07

0.48

2.42

–1

0.04

0.1

0.04

0.11

0.05

0.24

1

–0.04

–0.10

–0.04

–0.11

–0.05

–0.24

10

–0.39

–0.98

–0.41

–1.05

–0.48

–2.36

50

–1.95

–4.75

–2.05

–5.09

–2.36

–11.26

100

–3.86

–9.13

–4.06

–9.76

–4.66

–21.23

200

–7.54

–16.93

–7.91

–18.03

–9.08

–37.89

300

–11.04

–23.64

–11.59

–25.08

–13.28

–50.96

the % price change is not the same for an increase in the required yield as it is for a decrease in the required yield. the % price change for a given bond is roughly the same. whether the yield required increases or decreases. For a given large change in basis points. the % price increase is greater than the % price decrease. .Price Volatility of Option-Free Bond Although the prices of all option-free bonds move in opposite direction from the change in yield required. the % price change is not the same for all bonds. For large changes in the required yield. For very small changes in the yield required.

the lower the coupon rate. the longer the term to maturity. . the price volatility of a bond is greater.Price Volatility For a given term to maturity and initial yield. The higher the YTM at which a bond trades. the lower the price volatility. For a given coupon rate and initial yield. the greater the price volatility.

1309 70.9013 88.Measures of Price Volatility price value of a basis point – gives dollar price volatility not % Bond 5-year 9% coupon 25-year 9% coupon 5-year 6% coupon 25-year 6% coupon 5-year zero-coupon 25-year zero- Initial Price (9% Yield) 100 100 88.2824 64.0308 0.362 11.071 Price at 9.357 64.3928 11.0265 .0364 0.0987 0.9604 99.0396 0.0746 0.01% 99.0445 Price Value of a BP yield value of a price change duration 0.0945 70.

Duration .

120785 8. t CF PV of $1 at 4.50 0.30622 4.73318 7 4.306728 23.87899 .02807 27.734828 3.455531 20.50 0.50 0.00% Term (years): 5 Initial yield: 9.90442 100 826.Duration Exhibit 4-5.05514 6 4.876296 3.50 0.25262 10 104.0941 5 4. Calculation of Macaulay Duration and Modified Duration Coupon rate: 9.24156 3 4.943335 11.30622 2 4.956937 4.50 0.703185 3.672904 3.00% Period.5% PV of CF t x PVCF 1 $4.50 0.164333 25.14709 8 4.915729 4.767895 3.50 0.50 0.290443 672.83 4 4.773526 15.643927 67.838561 3.802451 3.31466 9 4.50 0.61103 18.50 0.

915729 2.303687 7 3.87644 18.8952 .82212 15.88666 10.130923 t x PVCF 2.956937 2.16841 663. t CF PV of $1 at 4.00% Term (years): 5 Initial yield: 9.00 0.43139 16.03676 13.74719 3 3.838561 2.00 0.876296 2.734828 2.109555 9 3.407353 6 3.703185 2. Calculation of Macaulay Duration and Modified Duration Coupon rate: 6.672904 2.515684 5 3.643927 66.00 0.06273 12.00 0.87081 5.767895 2.62889 4 3.870813 2 3.802451 2.018713 10 103.00 0.Duration Exhibit 4-6.324551 88.00 0.00% Period.5% PV of CF 1 $3.00 0.204485 8 3.00 0.24551 765.00 0.49437 7.00 0.

Modified Duration .

Duration duration is less than (coupon bond) or equal to (zero coupon bond) the term to maturity all else equal. the lower the coupon. the larger the duration the longer the maturity. the greater the price volatility . the larger the duration the longer the duration. the larger the duration the lower the yield.

the floater’s price will change by about 1.Duration dollar duration = (-MD) * P spread duration – measure of how a non-Treasury bond’s price will change if the spread sought by the market changes spread duration = 0 for Treasury for fixed rate security it is the approximate change in the price of a fixed-rate bond for a 100 bp change in the spread for a floater.4% portfolio duration – weighted average of bonds’ durations . a spread duration of 1.4 means that if the spread the market requires changes by 100 bp.

047 9.231.861 8.Portfolio Duration Bond 10% 5yr 8% 15yr 14% 30yr Par Amt Owned $4 million $5 million $1 million Bond 10% 5yr 8% 15yr 14% 30yr Price ($) 100.168 .375 $1.8586 Market Value $4.6275 137.0000 84.000 $4.378.000.586 Yield (%) 10 10 10 Duration 3.

249 9.168 63.378.Portfolio Duration Bond Market Value 10% 5yr 8% 15yr 14% 30yr $4.586 Duration Change in Value for 50bp Change in Yield 3.861 $77.000.194 Total $310.000 $4.375 $1.231.047 170.663 .220 8.

Measures of Bond Price Volatility .

Price-Yield Relationship .

Price Approximation using Duration .

divide by 4 .Convexity second derivative of price-yield is dollar convexity measure of bond convexity measure convexity measure in terms of periods squared so to convert to annual figure.

767895 0.50 $4.495 12.571 208.886 22.632 249.02 .50 $4.876296 0.980 7.50 $4.672904 0.703185 0.901 169.641 43.50 $4.50 t(t + 1)CF 0.589663 9 27 54 90 135 189 252 324 405 11.50 $4.838561 0. t 1 2 3 4 5 6 7 8 9 10 CF $4.201 132.19 7.50 $104.778.50 $4.734828 0.50 $4.616198 0. Selling to Yield 9% (Price = 100) Period.Calculation of Convexity for 5 Year.643927 0.802451 0. 9%.332 69.50 $4.781.56 6.11 99.

703185 0. 6%.00 $3.00 $3.373 6.00 $3.1309) Period.838561 0.094 28. t 1 2 3 4 5 6 7 8 9 10 CF $3.00 $3.00 $3.672904 0.680.088 166.89 7.00 $3.767895 0.643927 0.320 5.00 $3.589663 6 18 36 60 90 126 168 216 270 11.802451 0.257 15.601 113.876296 0.616198 0.Calculation of Convexity for 5 Yr.349.888 46.00 $3.073 66.00 $103.45 .330 12.00 t(t + 1)CF 0.047 139.734828 0. Selling to Yield 9% (P=88.134 88.

357 to yield 9% .Convexity consider the 25-year 6% bond selling at 70.

% Price Change consider a 25 year 6% bond selling to yield 9% MD = 10.66% = -17.62.24% + 3.58% . convexity = 182.92 required yield increases 200 bp from 9% to 11% estimated price change due to duration and convexity is 21.

Convexity implication of convexity for bonds when yields change market takes convexity into account when pricing bonds but to what extent should there be difference? .

the convexity of a bond decreases (increases). As the required yield increases (decreases). 3. the greater the convexity of a bond. 2. This property is referred to as positive convexity. the lower the coupon. For a given yield and modified duration. For a given yield and maturity. .Convexity 1. the lower the coupon. the smaller the convexity.

Use the 25 year.3570. the duration can be approximated as follows .= 71. is 70.Approximating Duration 1. 6% bond trading at 9%. P0.1105. So ∆y = 0.001.9%. The new price is P. The new price is P+ = 69.1%. 2.6164. Decrease the yield on the bond by 10 bp from 9% to 8. Increase the yield by 10bp from 9% to 9. Because the initial price. 3.

Increase the yield on the bond by a small number of bp and determine the new price at this higher yield level. New price is P+. PLetting P0 be the initial price. This gives the average % price change relative to the initial price per 1-bp change in yield.Approximating Duration 1. 3. Decrease the yield on the bond by the same number of bp and calculate the new price. . 2. duration can be approximated using the following where ∆y is the change in yield used to calculate the new prices.

Approximating Convexity .

09 .438/0790 0.43.9 940/ .7-43/803.

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