# 5.2.BKM Ch 16 (Duration & Convexity)

 6 general properties of bond prices Bond prices and yields are inversly relatedIncr in yield has smaller impact than comparable decr in yieldLong term bonds are more sensitive to changes in yieldsSensitivity to chg in yield incr at decr rate as mat incrHigh coupon bonds are less sensitive to chg in yieldSensitiviy of bond price to chg in yield is inversly related to yield at which it's currently selling Duration formulas Basic formulasD = ∑ ti (CFt / (1 + y)t) / BD* = D / (1 + y)∆P/P = -D*∆yC = 1 / P(1 + y)² ∑[(CFt/(1 + y)t t(t+1)]∆P/P = -D*∆y + ½C(∆y)² ApproximationsD* ≈ (P- - P+) / 2P∆yC ≈ (P- + P+ - 2P) / P(∆y)² Continuous compoundingD* = DD = ∑ ti (CFt e-yti) / BC = 1 / P ∑[ti² CFt e-yti] Duration vs Convexity Duration is only good for small changes in rates. For slightly higher changes, we use Convexity to adjust estimated change in price. Why do investors like Convexity It causes the price of bond to increase more when yield fall then they decrease when yield rises. This asymetry is desirable and causes an increase in E(r) for bonds as yield volatility increases. Duration of a PF Weighted avg of durations AuthorExam9 ID67439 Card Set5.2.BKM Ch 16 (Duration & Convexity) DescriptionBKM Updated2011-02-19T16:59:40Z Show Answers