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

What is corporate social responsibility, (a) The term "financial reporting"...

(a) The term "financial reporting" incorporates not only financial statements, but also includes other means of communicating financial and non-financial information. Financial rep

Explain the political events in a host country, Discuss the different ways ...

Discuss the different ways political events in a host country may affect local operations of an MNC. Answer:  The answer can be organized based on the three types of political ri

Financial asseta and time value of money, assume that risk free rate is 8% ...

assume that risk free rate is 8% and expected rate of return in market is 12%. what is the required rate of return on stock with a beta of 0.8%

London stock exchange, London Stock Exchange (LSE) The origin of the Lo...

London Stock Exchange (LSE) The origin of the London Stock Exchange goes back to the coffee houses of 17th century. London, where people willing to invest or raise money, bough

Lien, A legal claim on exact assets which were used to make loan secure.

A legal claim on exact assets which were used to make loan secure.

NPV, 2.5. Västerås Corporation plans to buy a truck for $40,000 and depreci...

2.5. Västerås Corporation plans to buy a truck for $40,000 and depreciate it fully over 5 years using straight-line method of depreciation. However, it plans to use it for 8 years

Calculate amount of first coupon payment your organization, Your firm has p...

Your firm has presently issued five year floating-rate notes indexed to six-month U.S. dollar LIBOR plus 1/4%.  What is the amount of first coupon payment your organization will pa

Statement of total comprehensive income for the year, At 31 July 2010 this ...

At 31 July 2010 this instrument meets the definition of a derivative: Small or no initial investment. Its value is dependent on an underlying economic item; exchange ra

Management accounting and financial management, Q. Distinguish between Mana...

Q. Distinguish between Management Accounting and Financial Management with clear mention of basis of differences. How does the traditional financial manager differ from the mode

Acquisition strategy, T he acquisition strategy The most important str...

T he acquisition strategy The most important strategic consideration is the size of the acquisition. The completion of smaller series should be considered in the beginning tha

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