Duration, Financial Management

Assignment Help:

Now that we have an understanding about price volatility characteristics of a bond, let us turn to the duration/convexity approach, which is an alternative approach to full valuation. Duration is the change in the value of bond that will result from a hundred basis point change in yield. Since this approach uses both

measures - duration and convexity, it is named as duration/convexity approach. Duration is the first approximation of the percentage change in price. Convexity is used to improve the estimate provided by duration.

Duration of the bond is calculated as follows:

         1063_duration.png

If we assume,

         Δy = Change in yield in decimal.

         V0 = Initial price.

         V- = Price if yields decline by Δy.

         V+ = Price if yields increase by Δy.

          1990_duration1.png                                                                                  ...Eq.(1)

For example, consider an 8.5% coupon 20-years option-free bond selling at Rs.115.89 to yield 7% (refer table 9). Let's assume that there are both side changes in the yield by 25 basis points. After the increase of 25 basis points from 7.00% to 7.25%, the price decreases to Rs.112.99.  When yield decreases by 25 basis points from 7.00% to 6.75%, the price increases to Rs.118.91.

Substitute values in Eq. (1) to get the duration of the bond as given below:

         Δy = 0.0025

         V0 = Rs.115.89

         V- = Rs.118.91

         V+ = Rs.112.99

Then,

         Duration = 1049_duration2.png

         Duration = 10.22

Duration of 10.22 means that the there will be 10.22% change in the price of this bond for a 100 basis point change in yield.


Related Discussions:- Duration

Monte-carlo simulation model and option adjusted spread, We have seen...

We have seen the valuation of bonds with embedded option using binomial model. This method can be used when cash flows do not depend on how interest rates evolve.

Type of assets, type of assets for ppt from t.y.bom com student in commerce...

type of assets for ppt from t.y.bom com student in commerce department in financial management

Cost of equity share capital, Cost of Equity Share Capital (ke) The co...

Cost of Equity Share Capital (ke) The cost of equity capital is the 'maximum rate of return that the Co. must earn on equity financed portion of its investments in order to go

Challenges facing by the finance manager, FUNCTIONS / RESPONSIBILITIES / CH...

FUNCTIONS / RESPONSIBILITIES / CHALLENGES FACING THE FINANCE MANAGER Today's finance manager is facing a lot of challenges, which are the direct result of the dynamic growth in

What is bridge financing, Bridge Financing A type of short-term financ...

Bridge Financing A type of short-term financing used to cover an organization short-term want; a loan that is expected to be repaid relatively fast.

Define why it is difficult to forecast future exchange rates, Researchers f...

Researchers found that it is extremely difficult to forecast the future exchange rates more precisely than the forward exchange rate or the current spot exchange rate. How would yo

Yield curve shift, The relative change in the yield for each treasury...

The relative change in the yield for each treasury maturity is known as a shift in the yield curve. When the change in the yield for all the maturities is same, t

Estimate the companys wacc, Assemble all other inputs/assumptions based on ...

Assemble all other inputs/assumptions based on the past data. Use your best judgment to have the most reasonable estimates. Tasks 1. Prepare an Excel spreadsheet containi

Show the accounting profit criteria, Q. Show the Accounting Profit Criteria...

Q. Show the Accounting Profit Criteria? Accounting Profit Criteria: - Under accounting profit criteria there is merely one method for making capital expenditure decisions. This

Binomial model, The option features embedded in many bonds and fixed-...

The option features embedded in many bonds and fixed-income securities have made the binomial interest rate tree approach a valuable model for pricing debt. Binomial

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd