Scribd Logo
Upload

Welcome to Scribd!

  • 33 views

    Managing Bond Portfolios: Mcgraw-Hill/Irwin

    Uploaded by

    Bujana Bujana
    Portofolio Management

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd

    Managing Bond Portfolios: Mcgraw-Hill/Irwin

    Uploaded by

    Bujana Bujana
    33 views27 pages
    Portofolio Management

    Original Title

    Chapter 011

    Copyright

    © © All Rights Reserved

    Available Formats

    PPT, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Portofolio Management

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    33 views27 pages

    Managing Bond Portfolios: Mcgraw-Hill/Irwin

    Uploaded by

    Bujana Bujana
    Portofolio Management

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 27

    CHAPTER 11

    Managing Bond Portfolios

    McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.


    11.1 INTEREST RATE RISK

    11-2
    Interest Rate Sensitivity

    Inverse relationship between price and


    yield
    An increase in a bond’s yield to maturity
    results in a smaller price decline than the
    gain associated with a decrease in yield
    Long-term bonds tend to be more price
    sensitive than short-term bonds

    11-3
    Interest Rate Sensitivity (cont)

    Sensitivity of bond prices to changes in


    yields increases at a decreasing rate as
    maturity increases
    Interest rate risk is inversely related to
    bond’s coupon rate
    Sensitivity of a bond’s price to a change in
    its yield is inversely related to the yield to
    maturity at which the bond currently is
    selling

    11-4
    Figure 11.1 Change in Bond Price
    as a Function of YTM

    11-5
    Duration
    A measure of the effective maturity of a bond
    The weighted average of the times until each payment is received,
    with the weights proportional to the present value of the payment
    Duration is shorter than maturity for all bonds except zero coupon
    bonds
    Duration is equal to maturity for zero coupon bonds

    11-6
    Figure 11.2 Cash Flows of 8-yr Bond with
    9% annual coupon and 10% YTM

    11-7
    Duration: Calculation

    t
    w t  [CFt (1  y ) ] Price
    T
    D   t wt
    t 1

    CF t  Cash Flow for period t

    11-8
    Duration Calculation

    8% Time Payment PV of CF Weight C1 X


    Bond years (10%) C4

    1 80 72.727 .0765 .0765

    2 80 66.116 .0690 .1392

    3 1080 811.420 .8539 2.5617


    Sum
    950.263 1.0000 2.7774

    11-9
    Figure 11.3 Duration as a
    Function of Maturity

    11-10
    Duration/Price Relationship

    Price change is proportional to duration


    and not to maturity
    P/P = -D x [y / (1+y)]
    D* = modified duration
    D* = D / (1+y)
    P/P = - D* x y

    11-11
    11.2 PASSIVE BOND MANAGEMENT

    11-12
    Immunization

    Passive management
    – Net worth immunization
    – Target date immunization

    11-13
    Figure 11.4 Growth of Invested Funds

    11-14
    Figure 11.5 Immunization

    11-15
    Cash Flow Matching and Dedication

    Automatically immunizes a portfolio from


    interest rate movements
    – Cash flow from the bond and the obligation
    exactly offset each other
    Not widely pursued
    Sometimes not even possible

    11-16
    11.3 CONVEXITY

    11-17
    Limitations of Duration

    Duration is only an approximation


    Duration asserts that the percentage price
    change is directly proportional to the
    change in the bond’s yield
    Underestimates the increase in bond
    prices when yield falls
    Overestimates the decline in price when
    the yield rises

    11-18
    Pricing Error from Convexity

    Price

    Pricing Error from


    Convexity

    Duration

    Yield

    11-19
    Correction for Convexity
    Modify the pricing equation:

    P
      D   y  1  Convexity  (  y ) 2
    P 2
    Convexity is Equal to:

    1 N  CF t 
    2   
    t t
    2
     t 
    P  (1  y) t 1  (1  y ) 

    Where: CFt is the cash flow (interest


    and/or principal) at time t.

    11-20
    Figure 11.6 Bond Price Convexity

    11-21
    Figure 11.7 Convexity of Two Bonds

    11-22
    11.4 ACTIVE BOND MANAGEMENT

    11-23
    Swapping Strategies
    Substitution swap
    Intermarket swap
    Rate anticipation swap
    Pure yield pickup
    Tax swap

    11-24
    Horizon Analysis

    Analyst selects a particular investment


    period and predicts bond yields at the end
    of that period

    11-25
    Contingent Immunization

    Allow the managers to actively manage


    until the bond portfolio falls to a threshold
    level
    Once the threshold value is hit the
    manager must then immunize the portfolio
    Active with a floor loss level

    11-26
    Figure 11.8 Contingent Immunization

    11-27

    You might also like