Measuring interest rate risk , Financial Management

Assignment Help:

Investors are always interested in estimating the price sensitivity of a bond to change in market interest rates. Let us study how prices change both in terms of percentage price change from the initial price, and the rupee price change from the initial price.

  1. Approximate Percentage Price Change: The percentage price change can be determined by calculating the average of the percentage price change resulting from an increase and a decrease in interest rates of the same number of basis points. When percentage price change for a 100 basis point change in yield is calculated, it is referred to as duration. For, duration is a measure of the price sensitivity of a bond to a change in yield. Formula for estimating the approximate percentage price change for a 100 basis point change in yield is as follows:

                   573_percentage price change.png

Illustration

Price if yield decreases by 20 basis points = Rs.95.5

Price if yields rise by 20 basis points = Rs.92.2

Initial price = 90

Change in yield in decimal = 0.002

Substituting these values in our formula we get:

Approximate percentage price changes =  855_percentage price change1.png

                                                     =  9.17%

So, if the duration of a bond is 9.17, we can interpret it as the approximate price change if yields change by 100 basis points is 9.17%. Similarly, the approximate percentage change in yield for 50 basis points in yield is 4.59%.

           ii. Approximating the Rupee Price Change: Let us consider our earlier illustration. Let us say that bond XYZ has duration of              9.17. If the portfolio manager owns bonds whose market value is Rs.50,00,000, then for 100 basis point change in yield, the            approximate rupee price change would be equal to 9.17 times of Rs.50,00,000, i.e. Rs.4,58,50,000. Similarly, for a 50 basis                point change, the approximate rupee change would be Rs.229,25,000. The approximate rupee price change for a 100 basis                 point change in yield is referred to as the rupee duration.


Related Discussions:- Measuring interest rate risk

Conservative approach of financial management, Q. Conservative Approach of ...

Q. Conservative Approach of Financial Management? An exact matching plan may not be followed in practice. A firm may adopt a conservative approach in financing its current and

What the term objective denotes- financial management, What the term object...

What the term objectives denotes- financial management It must be noted at the outset that term 'objective' is used in the sense of a goal or decision criterion for three decis

Opperating cyles, discuss the applicability of operating cycles of vegetabl...

discuss the applicability of operating cycles of vegetable growing

Zero-volatility spread, The zero-volatility spread is a measure of th...

The zero-volatility spread is a measure of the spread that the investor would realize over the entire Treasury spot rate curve if a mortgage-backed or asset-backe

Describe the value maximisation criterion, Describe the value maximisation ...

Describe the value maximisation criterion In applying the value maximisation criterion, term value is used in terms of worth to the owners, which is, ordinary shareholders. Cap

What is the importance of investigation of incidents, Q. What is the import...

Q. What is the importance of investigation of incidents? 1. Incident investigation is the process of identifying the underlying causes of incidents and implementing steps to pr

Explain safe harbour rule, Q. Explain Safe Harbour Rule? Safe Harbour R...

Q. Explain Safe Harbour Rule? Safe Harbour Rule - Concept in statutes and regulations whereby a person who meets listed requirements would be preserved from adverse legal actio

Cost of Capital, The Nu-Nu Brothers Inc. (NNBI) has the following capital s...

The Nu-Nu Brothers Inc. (NNBI) has the following capital structure, which it considers to be optional: Debt 25% Preferred Stock 15% Common Equity 60% NNBI''s expected net income t

Leverage, Evaluate d importance of leverage in a financial management of a ...

Evaluate d importance of leverage in a financial management of a small sacle business

Source documents of an accounting system, Source documents of an accounting...

Source documents of an accounting system: Source documents are those documents that identify the particular transaction that is being recorded.  They act as an internal control

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