Discussion Thread: Investing, Budgeting, Wealth Management
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ManagingBondPortfolios.pptxManaging Bond Portfolios
Bodie, Kane, and Marcus
Essentials of Investments Eleventh Edition
11
Chapter
11.1 Interest Rate Risk
Interest Rate Sensitivity
Bond prices and yields are inversely related
Increase in bond’s yield to maturity results in smaller price change than yield decrease of equal magnitude
Long-term bond prices more sensitive to interest rate changes than short-term bonds
As maturity increases, sensitivity of bond prices to changes in yields increases at decreasing rate
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11.1 Interest Rate Risk
Interest Rate Sensitivity
As maturity increases, sensitivity of bond prices to changes in yields increases at decreasing rate
Interest rate risk is inversely related to bond’s coupon rate; low-coupon bonds are more sensitive to interest rates
Sensitivity of bond’s price-to-yield change is inversely related to current yield to maturity
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Figure 11.1 Change in Bond Prices as a Function of Change in Yield to Maturity
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11.1 Interest Rate Risk: Coupons Rate and Sensitivity
Prices of zero-coupon bonds
Prices of 8% annual coupon bonds
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11.1 Interest Rate Risk
Macaulay’s Duration
Measures effective bond maturity
Weighted average of the times until each payment, with weights proportional to the present value of payment
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Spreadsheet 11.1 Calculation of Duration of Two Bonds
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11.1 Interest Rate Risk
Change in Bond Price to Yield to Maturity
Modified Duration
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Spreadsheet 11.2 Computing Duration
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11.1 Interest Rate Risk
What Determines Duration?
Zero-coupon bond’s duration is time to maturity
Time/yield to maturity constant, bond’s duration and interest-rate sensitivity higher when coupon price lower
Coupon rate constant, bond’s duration and interest-rate sensitivity generally increase with time to maturity; duration always increases with maturity for bonds at or above par
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11.1 Interest Rate Risk
What Determines Duration?
Other factors constant, duration and interest rate sensitivity of coupon bond higher when bond’s yield to maturity lower
Duration of a perpetuity
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Figure 11.2 Duration as Function of Maturity
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Table 11.3 Annual Coupon Bond Duration
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11.2 Passive Bond Management
Immunization
Strategy to shield net worth from interest rate movements
Rebalancing
Realigning proportions of assets in portfolio as needed
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Table 11.4 Terminal Value of Bond Portfolio after Five Years
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Figure 11.3 Growth of Invested Funds
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Table 11.5 Market Value Balance Sheets
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Figure 11.4 Immunization
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11.2 Passive Bond Management
Cash Flow Matching and Deduction
Cash flow matching
Matching cash flows from fixed-income portfolio with those of obligation
Deduction strategy
Multi-period cash flow matching
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11.3 Convexity
Convexity
Curvature of price-yield relationship of bond
Why Do Investors Like Convexity?
More convexity = greater price increases, smaller price decreases when interest rates fluctuate by larger amounts
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Figure 11.5 Bond Price Convexity
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11.4 Active Bond Management: Strategies
| Sources of Potential Profit | Strategy |
| Substitution swap | Exchange of one bond for bond with similar attributes and better price |
| Intermarket swap | Switching from one segment of bond market to another |
| Rate anticipation swap | Switch made in response to forecasts of interest rate changes |
| Pure yield pickup swap | Moving to higher yield bonds, usually with longer maturities |
| Tax swap | Swapping two similar bonds to receive tax benefit |
| Horizon analysis | Forecast of bond returns based largely on prediction of yield curve at end of investment horizon |
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11.4 Active Bond Management
Fixed-Income Investment Strategy
Key features
Firms respect market
