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MANAGEMENT
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BOND PORTOLIOS
METHODS OF MANAGEMENT
Passive
rests on the belief that bond markets are semi-strong
efficient
current bond prices viewed as accurately reflecting
all publicly available information
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BOND PORTOLIOS
METHODS OF MANAGEMENT
Active
rests on the belief that the market is not so efficient
some investors have the opportunity to earn above-
average returns
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BOND PRICING THEOREM S
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BOND PRICING THEOREM S
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BOND PRICING THEOREM S
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BOND PRICING THEOREM S
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BOND PRICING THEOREM S
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BOND PRICING THEOREM S
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CONVEXITY
CONVEXITY DEFINITION:
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CONVEXITY
THE PRICE-YIELD RELATIONSHIP
Price
YTM
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CONVEXITY
THEOREM 1 TELLS US
price and yield are inversely related but not in a
linear fashion (see graph)
an increase in yield is associated with a drop in
bond price
but the size of the change in price when yield
rises is greater than the size of the price change
when yield falls
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DURATION
DEFINITION:
measures the average maturity of a stream of
bond payments
it is the weighted average time to full recovery
of the principal and interest payments
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DURATION
FORMULA
T
PV (Ct )
D = t
1
t= P0
where P0 = the current market price of
the bond
PV(Ct )= the present value of the
coupon payments
t = time periods
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DURATION
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DURATION
DURATION IS A PRICE-RISK
INDICATOR
FORMULA
p
D[ (1 + ytm)]
p
rewritten p y
D
1 +y
p
where y = the bonds yield to maturity
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DURATION
MODIFIED DURATION
FORMULA: D
Dm =
1 +y
reflects the bonds % price change for a one
percent change in the yield
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DURATION
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DURATION
THE RELATIONSHIP BETWEEN CONVEXITY AND DURATION
P
0 YTM
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IM MUNIZATION
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IM MUNIZATION
HOW TO ACCOMPLISH
IMMUNIZATION
Duration of a portfolio of bonds
equals the weighted average of the individual bond
durations in the portfolio
Immunization
calculate the duration of the promised outflows
invest in a portfolio of bonds with identical
durations
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IM MUNIZATION
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ACTIVE M ANAGEM ENT
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ACTIVE M ANAGEM ENT
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ACTIVE M ANAGEM ENT
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PASSIVE MANAGEM ENT
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