Scribd
Upload
69 views

Wk4tute Sol

The document discusses the concept of duration and its relationship to other bond characteristics. 1) Duration is inversely related to coupon rate and yield, and directly related to maturity. Higher coupon rates, yields, or shorter maturities result in lower duration. 2) Duration measures the weighted average time it takes to recover the cost of an investment from its cash flows. 3) For coupon bonds, duration is generally shorter than maturity since coupon payments are received before maturity. However, duration can equal or exceed maturity in some cases.

Uploaded by

humankind8
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
69 views

Wk4tute Sol

The document discusses the concept of duration and its relationship to other bond characteristics. 1) Duration is inversely related to coupon rate and yield, and directly related to maturity. Higher coupon rates, yields, or shorter maturities result in lower duration. 2) Duration measures the weighted average time it takes to recover the cost of an investment from its cash flows. 3) For coupon bonds, duration is generally shorter than maturity since coupon payments are received before maturity. However, duration can equal or exceed maturity in some cases.

Uploaded by

humankind8
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

Session 5:

Duration

A. Duration is the weighted average time for investors to recover the cost of their investment from the cash flows of the investment. The weight attached to each cash flow is defined as the present value of the cash flow divided by the cost. The time attached to each cash flow is defined as the time period when the cash flow is received. B. Answers:
Coupon rate 10% 12% 14% 16% 18% 20%
1.8 8 0 0 1.8 6 0 0

Duration 1.8684 1.8473 1.8276 1.8091 1.7918 1.7754

Years to maturity 2 4 6 8 10 12

Duration 1.8684 3.4483 4.8175 6.0257 7.1066 8.0833

YTM 5 7 9 11 13 15

Duration 1.8684 1.8657 1.8630 1.8602 1.8575 1.8547

Relationship betw een Duration & Coupon Rate: 2-year bond w ith yield of 5%

Duration

1.8 4 0 0 1.8 2 0 0 1.8 0 0 0 1.78 0 0 1.76 0 0 8% 10 % 12 % 14 % 16 % 18 % 20 % 22%

Coupon Rate

Re lations hip be tw e e n Duration & M aturity - 10% coupon bond w ith yie ld of 5% 10.0000 8.0000 Duration 6.0000 4.0000 2.0000 0.0000 0 2 4 6 8 10 12 14 Ye ars to M aturity Re lations hip be tw e e n Duration & Yie ld - 2-ye ar 10% coupon bond 1.8700 1.8650 Duration 1.8600 1.8550 1.8500 3 5 7 9 11 13 15 17 Yie ld to M aturity

The results and diagrams show that duration is i) inversely related to coupon rate. The higher the coupon rate, the sooner the investor will recover the cost of investment and hence the smaller duration. ii) directly related to maturity. The longer the maturity, the longer it takes to recover the cost of investment and hence the larger duration. iii) inversely related to yield to maturity. If you plot a diagram to illustrate the relationship between the yield and price of a bond, you should realise that the bond price decreases at a decreasing rate with yield. This relationship implies that the larger the yield, the lower the price sensitivity of a bond to interest rate changes. But smaller duration also corresponds to lower bond price sensitivity. Thus the larger the yield, the smaller the duration. C. From the session on bond pricing: As Coupon rate and maturity , price sensitivity . From the previous question: As Coupon rate and maturity , duration . Thus a direct relationship between duration and price sensitivity is expected. D. Since cash flows in the form of coupon interests are received prior to maturity, the investor does not need to wait until maturity to recover the cost of investment. Hence the duration of a coupon bond is generally smaller than its time to maturity. E. The duration is 0.5 years since the remaining cash flows (FV and final coupon interest) are all received six months later when the bond matures and the present value of the cash flows is equal to the cost of investment. Thus the duration of a coupon bond is not always smaller than its time to maturity. It can be the same as or less than the time to maturity. F. Yes, this investment is risk-free since you are certain of the cost and terminal value of the investment. G. Assumption 1: The yield curve is flat at the time of bond investment. This ensures that the expected return from the bond is the same return as its initial yield to maturity. Assumption 2: Any unexpected change in rates applies to the entire spectrum of maturities, i.e., the yield curve experiences a parallel upward/downward shift. This ensures that the unexpected rise (fall) in coupon reinvestment income offsets the unexpected fall (rise) in the selling price of the bond completely. Assumption 3: Prior to any unexpected change in rates, the bonds duration matches the intended holding period. Otherwise, price risks will not offset income risks completely.

You might also like