# B.02.BKM 16/Hull 7

### Card Set Information

 Author: Exam9_2012 ID: 135569 Filename: B.02.BKM 16/Hull 7 Updated: 2012-05-09 14:55:35 Tags: bond duration convexity immunization Folders: Description: Managing Interest Rate Risk Show Answers:

Home > Flashcards > Print Preview

The flashcards below were created by user Exam9_2012 on FreezingBlue Flashcards. What would you like to do?

1. Relationship btwn bd price & yield
• bd price & yield are inversly related
• incr in y leads to smaller chg in P than same size decr
• as term inc, price more sensitive to chg in y
• sensitivity of price incr at decr rate as maturity incr
• lower coupon bds are more sensitive to chg in y
• sensitivity of bd price to yield inversly related to y
2. Duration
• measures avg maturity of financial instrument's CF
• used to (1) summarize avg maturity (2) immunize pf (3) measure int rate sensitivity
• D* = D / (1 + y/k)
3. Properties of Duration
• duration of zero-coupon bd = time to maturity
• D decr as coupon rate incr
• D generally incr as maturity incr
• D incr as ytm decr
• D perpetuity = (1 + y) / y
4. Convexity
• D approximation always understates bd value
• as C incr, bd appreciates more when y falls, depr less when yield rise
5. Convexity of a callable bond
• As value approaches call price, negative convexity
6. Immunization
• passive mgt strategy
• create pf w duration = investment horizon
• due to convexity, this produces a surplus
• (-) once duration changes, requires rebalancing
• (-) based on D -> assumes flat yield curve
• (-) only effective for parallel shifts in yield curve
• (-) inappropriate in inflationary environment
7. Cash Flow Matching / Dedication
• Passive mgt strategy
• CF matching: buy zero-coupon which matches future obligations
• Dedication: CF matching over multiple periods
• (+) automatically immunizes pf from chg in int rate
• (+) no rebalancing
• (-) hard to implement -> strong constraints on selectable bds
8. Contingent immunization
• mix of active and passive mgt strategies
• start w active until reaches trigger point
• if active threatens ability to meet obligations, switch to passive
9. Tools to modify pf duration
• Mortgage Backed Securities: diff tranches have diff durations
• Swaps: can transform fix into floating or vice versa

What would you like to do?

Home > Flashcards > Print Preview