Measurement of interest rate risk

Duration of a bond (D)
· Percentage change in price for a 100 basis point change in yield
· aka bond’s effective duration, go down or up by same no. of basis points
· Duration of zero coupon rate equals its maturity
· Duration of a floater coupon bond equals the time to the next reset date

D = (V_- V+) / (2 x Vo x dy in decimal)

Approximate bond price change = -1 x Duration x Price x dy

Dollar duration = -1 x Duration x Price / 100

Effect of yield level :
· Price volatility inversely related to the level of market yields. As yields increase, bond prices fall
· The price curve gets flatter and is referred to as positive convexity. The bond prices go up faster than they go down.