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

Define the matching principle of working capital financing, What is the mat...

What is the matching principle of working capital financing?  What are the advantages of following this principle? The matching principle is while short-term financing is employe

Callable bonds, Basics of  Callable Bonds A callable b...

Basics of  Callable Bonds A callable bond is a convertible bond with the favorable feature of call option available to the issuer. When the fir

Help with 4 questions, I need assistance with 4 questions. How do I know s...

I need assistance with 4 questions. How do I know someone can help me and have some idea of what it would cost before submitting the information? Also, how fast is the turnaround

Dividends, Company X is expected to maintain a constant 7% growth rate in t...

Company X is expected to maintain a constant 7% growth rate in their dividends, indefinitely. If company X has a dividend yield of 4%, what is the required return on their shares?

Interpolation applications in financial analysis, In financial analys...

In financial analysis, interpolation is used widely in: Determination of internal rate of return of a project. Finding out the yield to maturity (ytm)

Highest earnings-per-share, McGovern Company is comparing two disimilar cap...

McGovern Company is comparing two disimilar capital structures - an all-equity plan (Plan I) and a levered plan (Plan II).  Under Plan I, the Company would have 700,000 shares of s

Weak form level of efficiency-forms of efficiency, Weak form level of effic...

Weak form level of efficiency This level states that share prices fully reflect information in historic share price movement and patterns (past information/historic information

Account balance - inherent risk, Account balance - Inherent risk At a...

Account balance - Inherent risk At account balance / class of transaction level Balances susceptible to misstatement. History of errors. Complexity of transac

What are agency problems, What are agency problems? and between what two st...

What are agency problems? and between what two stakeholders do agency problem typically occur?

Investment decision and financing decision, The Investment Decision: - Inv...

The Investment Decision: - Investment decision as well known as 'Capital Budgeting' is related to the selection of long-term assets or else projects in which investments will be m

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