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MANAGING
THE FIXED INCOME PORTFOLIO
Convexity
Problems with Duration
Simple Convexity
An Example
Using Convexity
Management Strategies
Active vs. Passive Management
Classic Passive Management Strategies
The Risk of Barbells and Ladders
Indexing
Active Management
( 1 + R ) N +1 − ( 1 + R ) − RN
C t + FN N
R (1 + R)
2 N (1 + R)
D=
P
where F = face value (par value) of the bond
and all other variables are as previously defined.
dP 1 − 1 C1 2C 2 NC N 1
⋅ = + ++ N
⋅
dR P ( 1 + R ) ( 1 + R ) ( 1 + R )
1 2
(1 + R) P
DMacaulay
Dmodified =
(1+ R
2
)
P− − P+
Deffective =
P0 ( R+ − R − )
where P- = price of bond associated with a decline of x basis points
P+ = price of bond associated with a rise of x basis points
R- = initial yield minus x basis points
R+ = initial yield plus x basis points
P0 = initial price of the bond
1 N t ( t + 1) C t N ( N + 1 ) F
Convexity = ∑ +
P t =1 ( 1 + R ) t +2
(1 + R) N +2
bond price
yield to maturity