Reference no: EM133598268

Question: Bond valuation is the process of determining a bond's fair value or present value. The basic principle behind bond valuation is that the value of a bond is equal to the current value of its expected future cash flows. Interest rate risk is the potential for bond prices to change due to interest rate shifts. Existing bond prices typically drop if interest rates increase because new bonds offer better returns, making the older ones less desirable. On the other hand, when interest rates decrease, existing bonds become more favorable, causing their prices to increase. A bond's price sensitivity to interest rate changes is often measured by its duration, with longerematurity bonds being more susceptible to these rate shifts. To manage interest rate risk in bond investments, investors can use hedging techniques to lower interest rate risks. Typically, this involves using derivatives like interest rate swaps, options, futures, and forward rate agreements (FRAs). Also, to protect against the negative impacts of interest rate risk on a bond portfolio, investors can diversify by incorporating assets less affected by interest rate changes, such as equities. For those with an exclusively bond-focused portfolio, , including both short-term and long-term bonds can also offer diversification benefits