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Effective Duration (ED) = (value, yield falls by ∆ in y - value, yield rises by ∆ in y) / (2 * initial
value * ∆y)
Modified Duration (MD): assumes CF's on bond won't ∆ (unlike ED, which considers features
like embedded options)
Rebalancing Ratio = old DD / new DD, or required add'l cash to readjust P to original DD
Dollar Value of Basis Point (DVBP): ∆ in sec value for 1 bps ∆ in r (= duration * 1,000 * value)
Key Rate Duration: approx. % ∆ in bond value for 100 bps ∆ in a key rate, holding all other rates
constant. Useful to measure convexity, i.e. effect of non-parallel curve shift.
Yield Curve: graphical representation, term structure of int rates.. yield curve risk = non-parallel
shift in curve
Negative Convexity: e.g. callable. Duration lower at low rates (i.e. call price is the ceiling)
Bond Valuation: est. CF's over life, then compute PV using appropriate discount rate
Yields:
Current yield ==> annual coupon/bond price
** YTM assumes bond HTM & all interim CF's reinvested at YTM
Yield Spreads:
Z-Spread = spread added to all SR's on yield curve s.t. PV of CF's equals the mkt price (note that
same spread added to all).
Credit Spread: yield diff. b/w 2 issues that are identical except credit rating
Bootstrapping (implied spot rates): find rate s.t. mkt value of a certain coupon bond equals
discounted PV of the associated CF's.
(Usually are given one or more spot rates; use to discount CF's occurring on those dates. With
coupon bond price on left-hand side of equation, solve for missing SR.)
Forward rate: borrow/lending rate at some future pt. Investor indifferent b/w holding coupon
bond to maturity & receiving associated CF's and reinvesting at the forward rates.
e.g. 1-period forward rate, n periods from today= (1+ SR(n+1))^(n+1) / (1 + SR(n))^n - 1
Treasury Bond Futures: U/L instrument is $100K par value of 30-yr, 6% coupon. Seller can deliver
among several
acceptable instruments: at least 15 yrs to maturity from delivery date, must not be callable w/n
this period
(CBOT rules).
Interest Rate Futures: prices negatively correlated w/int rates (r increases ==> deliverable bond
p decreases ==>
futures p decreases). Therefore, P duration increases.
* est. ∆ in yield
(2) Duration/Convexity Approach (simpler). See "Duration" notes above for formulas.
Yield Curve Risk - major source; includes parallel shift (= 90% of bond value chg), twists and
other curvature chgs. Dimension via key rate duration.