Term
| What is DV01 and what does it measure? |
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Definition
DV01: is the absolute dollar change in bond price from a one basis point change in yield.
It's used when implementing fixed income hedging strategies |
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Term
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Definition
| Duration is an estimate of the percentage priec change in the bond price from a change in the term structure |
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Term
| Do DV01 and duration take non-linear aspects into account? |
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Definition
| No - they are linear approximations to a convex function. As the change in yield increases, these measures become progressively less accurate at predicting price changes. Convexity complements these measures by capturing the effects of the curvature of the price/yield relationship. |
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Term
| What do measures of interest rate sensitivity enable? |
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Definition
| they enable investors to evaluate bond price changes as a result of interest rate changes. |
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Term
| For whom is being able to properly measure price sensitivity useful? |
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Definition
- Hedgers
- Investors
- Portfolio managers
- Asset/liability managers |
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Term
| How do you calculate DV01? |
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Definition
DV01 = | price at YTM0 - price at YTM1 |
| | : absolute value
YTM0 : the initial yield to maturity
YTM1: the yield to maturity one basis point above or below YTM0
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Term
| What does the convexity relationship imply? |
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Definition
convexity relationship implies that a larger price increase occurs with a yield decrease than the price decrease associated with an identical yield increase.
This is a limitation of DV01 since it assumes that the price/yield curve is linear. |
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Term
| How can we convert DV01 (absolute dollar change from a 1 basis point change in yield) to a percentage price change? |
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Definition
PPC = DV01 / price at YTM0
(example - page 39 book 3) |
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Term
What do hedge ratios provide?
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Definition
hedge ratios provide the relative sensitivity between the position to be hedged and the instrument used to hedge the position
for example, a hedge ratio of 1 means that the hedging instrument and the position have the same interest rate sensitivity |
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Term
| What's the goal of a hedge? (in terms of bonds) |
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Definition
| to produce a combined position (initial position combined with the hedge position) that will not change in value for a small change in yield. |
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Term
| How do you calculate the Hedge Ratio? |
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Definition
| HR = DV01 (per $100 of initial position) / DV01 (per $100 of hedging instrument) |
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Term
Compute HR of a bond with DV01 of 0.17195624, the bond to be used a hedging instrument has a DV01 of 0.10458173
what does the result actually mean? |
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Definition
HR = .17195624 / 0.10458173 = 1.644
The result of 1.644 means that for every $1 par value of the 30 year bond, short $1.644 of par of the 15 year bond |
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Term
| A bond's price volatility is a function of... (3 things) |
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Definition
- coupon
- maturity
- initial yield |
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Term
| What's the formula for duration? |
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Definition
duration = (BV-Δy - BV+Δy ) / (2 * BV0 * Δy)
BV-Δy : estimated bond price if yield decreases by a given amount Δy
BV+Δy : estimated bond price if yield increases by a given amount Δy
BV0 : initial observed bond price
Δy: change in required yield, in decimal form |
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Term
| What's Macaulay duration? |
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Definition
| an estimate of a bond's interest rate sensitivity based on the time in years until promised cash flows will arive |
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