Fixed-IncomePortfolioManagement.pptVIP

Chapter 16 Fixed-IncomePortfolio Management Managing Fixed Income Securities: Basic Strategies Active strategy Trade on interest rate predictions Trade on market inefficiencies Passive strategy Control risk Balance risk and return Bond Pricing Relationships Inverse relationship between price and yield An increase in a bond’s yield to maturity results in a smaller price decline than the gain associated with a decrease in yield Long-term bonds tend to be more price sensitive than short-term bonds Bond Pricing Relationships (cont’d) As maturity increases, price sensitivity increases at a decreasing rate Price sensitivity is inversely related to a bond’s coupon rate Price sensitivity is inversely related to the yield to maturity at which the bond is selling Duration A measure of the effective maturity of a bond The weighted average of the times until each payment is received, with the weights proportional to the present value of the payment Duration is shorter than maturity for all bonds except zero coupon bonds Duration is equal to maturity for zero coupon bonds Duration: Calculation Duration Calculation: Example using Table 16.3 Duration/Price Relationship Price change is proportional to duration and not to maturity ?P/P = -D x [?(1+y) / (1+y) D* = modified duration D* = D / (1+y) ?P/P = - D* x ?y Rules for Duration Rule 1 The duration of a zero-coupon bond equals its time to maturity Rule 2 Holding maturity constant, a bond’s duration is higher when the coupon rate is lower Rule 3 Holding the coupon rate constant, a bond’s duration generally increases with its time to maturity Rule 4 Holding other factors constant, the duration of a coupon bond is higher when the bond’s yield to maturity is lower Rules for Duration (cont’d) Rules 5 The duration of a level perpetuity is equal to: Rule 6 The duration of a level annuity is equal to: Rules for Duration (cont’d) Rule 7 The duration for a corporate bond is equal to: Passive Management Bond-Index Funds Immunizatio