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

Geographical classification of mutual funds , Geographical Classification o...

Geographical Classification of Mutual Funds : Nations' boundaries provide territorial restrictions on the sale and purchase of mutual fund units or shares as is the case in com

Working capital management, I need a report on Working Capital Management. ...

I need a report on Working Capital Management. Can you please assist me for Working Capital Management report for about 2500 words?

Fixed weight aggregates method - fisher''s ideal method, Fixed Weight Aggre...

Fixed Weight Aggregates Method In fixed weight aggregates method, the weights used are neither from base period nor from current period but from a representative period. These

Credit standards for formulation of optimum credit policy, Q. Credit Standa...

Q. Credit Standards for Formulation of Optimum Credit Policy? Credit Standards: - Credit standards are the essential criteria set for extension of credit to customers. Decision

Irregular variation in time series analysis, Irregular Variation As the...

Irregular Variation As the name suggests, the movement of the variable is random in nature without consistency and therefore, highly unpredictable. Since this type of irregular

Strategies to achieve financial targets, The XYZ company supplies products ...

The XYZ company supplies products to a number of original equipment manufacturers (OEM's). It employs 5,000 mostly unionized workers and generates about $2.2 billion in revenue ann

Define main trends which prevailed in international business, Discuss the t...

Discuss the three main trends which have prevailed in international business throughout the last two decades. The 1980s brought a fast integration of financial markets and inter

Allocation head for revenue expenditure, Q. Allocation head for Revenue Exp...

Q. Allocation head for Revenue Expenditure? All revenue expenditure is recorded in revenue allocation registers by various heads of accounts classification, The expenditure on

Define conservative type of working capital financing plan, What is the mos...

What is the most conservative type of working capital financing plan a company could implement?  Explain. An all equity capital structure would be mainly conservative type of wor

Illustrate the meaning of gearing, Illustrate the meaning of Gearing G...

Illustrate the meaning of Gearing Gearing is the relationship between equity anddebt. Debt is typically long term liabilities that the organisation has. Equity is all the shar

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