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Chapter 4 (part II) (Investment horizon vs MD (Investment horizon =…
Chapter 4 (part II)
Investment horizon vs MD
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Investment horizon < Macaulay duration => market price risk dominates coupon reinvestment risk (risk of increase in interest rate)
Investment horizon > Macaulay duration => coupon reinvestment risk dominates market price risk (risk of decrease in interest rate)
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Effective duration
another approach to assess the interest rate risk of a bond is to estimate the % change in price given a change in a benchmark yield curve (the government par curve)
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A bond with an embedded option (such as callable/ putable bond) does not have a well- defined internal rate of return (YTM) => Effective duration is the appropriate duration measurement
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Price value of a basis point (PVBP): estimate of change in the full price given 1bp change in the YTM