The price volatility properties of bonds with the help of the graph of the price/yield relationship. Let us now, with the help of a graph, illustrate how duration estimates the percentage price changes.

Figure 1: Price/Yield Relationship for an Option-free Bond with a Tangent Line

The price/yield relationship curve for an option-free bond has a convex shape; this is reflected in Figure 9. In the chart we can see a tangent line touching the curve at point z where price is equal to p* and yield is equal to y*. In the new price, the yield changes is estimated using the tangent line. The distance between the horizontal axis and the tangent line represents the price approximated by using duration starting with the initial yield y*. 

Posted Date: 9/10/2012 5:13:07 AM | Location : United States

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