Chapter 17
Bonds-Analysis And
Management
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1
Bond Pricing Principles
•
•
•
•
Bond Prices and the Passage of Time
Bond Prices and Changes in Yield to Maturity
Bond Price Sensitivity and Maturity
Changes in Bond Price Sensitivity and
Changes in Time to Maturity for Various
Maturities
• Bond Price and Coupon
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Bond Prices And The
Passage Of Time
• Price and Value Change
with the Passage of Time
• Premium
• Par
• Discount
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Bond Prices And Changes In
Yield To Maturity
• Prices are Inversely Related to
Yield to Maturity
• Price-Yield Relationship is
Convex
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Bond Price Sensitivity And
Maturity
• Different for Various Bond Maturities
• The Longer the Maturity
– The more sensitive the bond’s price to
change in the yield to maturity
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Does a 1-year or 10-year 10% bond
have more interest rate (or price) risk?
Interest rate risk: Rising kd causes
bond’s price to fall.
kd
1-year Change 10-year Change
5% $1,048
10%
1,000
15%
956
®1999 South-Western College Publishing
+4.8%
-4.4%
$1,386
1,000
749
+38.6%
-25.1%
Value
10-year
.
.
1,500
1,000
.
.
.
1-year
500
kd
0
0%
5%
®1999 South-Western College Publishing
10%
15%
Changes In Bond Price
Sensitivity And Changes In
Time To Maturity For Various
Maturities
• Increases at a Decreasing Rate
– With the length to maturity
• 5 and 10-Year Bond
• 25 and 30-Year Bond
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Bond Value ($)
1,372
1,211
kd = 7%.
kd = 10%.
1,000
M
837
kd = 13%.
775
30
25
20
15
10
5
0
Years remaining to Maturity
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Bond Price And Coupon
• Linear Relationship
• Drift Towards Par Value
– With just the passage of time
• The Higher the Coupon Rate
– The less sensitive the bond to changes in
yield to maturity
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Is There A Way To Reduce Or
Eliminate The Interest-Rate
Risk?
• Duration
– Holding period
– Price effect
– Reinvestment effect
– Calculating duration next slide
– Measures the sensitivity
– Used by investment analysts
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Calculating Duration
T
D =  tWt
t=1
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Duration Principles
• Duration
– Declines over time
– Inversely related to yield to maturity
– Directly related to maturity
– Inversely related to level of coupon
payment
– Bond portfolio
• More Than One Factor
– Relationship becomes more complex
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How Do You Measure The
Curvature Of A Bond’s PriceYield Relationship?
• Convexity
– Basic principles
• Inversely related to yield to maturity
• Inversely related to the coupon
• Positively related to duration
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Income
Immunization
Price
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Income Immunization
• Strategies
– Cash matching
– Duration matching
– Horizon matching
• Protects Future Income Needs
• Ignores Current Market Value
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Price Immunization
• Protects Current Market Value
• Uses Convexity
• The Greater the Convexity
– The greater the gain from changes in
interest rates
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Passive Bond Management
• Mimic a Bond Index
• Is the Bond Market Efficient?
– Yes
Passive management
– No
Active management
• Refining Immunization Techniques
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Active Bond Management
• Contingent Immunization
– Timing strategies
– Duration mismatches
– Floor on active manager’s performance
• Popular Active Bond Management Strategies
– Substitution swap
– Pure Yield pickup swap
– Intermarket spread swap
– Rate anticipation swap
®1999 South-Western College Publishing
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