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Chapter 11 Managing Bond Portfolios Study Guide

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Chapter 11 - Managing Bond Portfolios
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
CHAPTER 11
MANAGING BOND PORTFOLIOS
1. Duration can be thought of as a weighted average of the ‘maturities’ of the cash flows paid to
holders of the perpetuity, where the weight for each cash flow is equal to the present value of
that cash flow divided by the total present value of all cash flows. For cash flows in the distant
future, present value approaches zero (i.e., the weight becomes very small) so that these distant
cash flows have little impact, and eventually, virtually no impact on the weighted average.
2. A zero coupon, long maturity bond will have the highest duration and will, therefore, produce the
largest price change when interest rates change.
3.
a. Engage in active bond management, specifically bond swaps
b. An intermarket spread swap should work. The trade would be to long the corporate bonds
and short the treasuries. A relative gain will be realized when the rate spreads return to
normal.
4. Change in Price = (Modified Duration Change in YTM) Price
=
Macaulay's Duration
1+ YTM
Change in YTM Price
Given the current bond price is $1,050, yield to maturity is 6%, and the increase in YTM and
new price, we can calculate D:
$1,025 $1,050 =
Macaulay's Duration
1+ 0.06
0.0025 $1,050 x D = 10.0952
5. d. None of the above.
6. The increase will be larger than the decrease in price.
7. While it is true that short-term rates are more volatile than long-term rates, the longer duration of
the longer-term bonds makes their rates of return more volatile. The higher duration magnifies
the sensitivity to interest-rate savings. Thus, it can be true that rates of short-term bonds are
more volatile, but the prices of long-term bonds are more volatile.
8.

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Chapter 11 - Managing Bond Portfolios CHAPTER 11 MANAGING BOND PORTFOLIOS 1. Duration can be thought of as a weighted average of the ‘maturities’ of the cash flows paid to holders of the perpetuity, where the weight for each cash flow is equal to the present value of that cash flow divided by the total present value of all cash flows. For cash flows in the distant future, present value approaches zero (i.e., the weight becomes very small) so that these distant cash flows have little impact, and eventually, virtually no impact on the weighted average. 2. A zero coupon, long maturity bond will have the highest duration and will, therefore, produce the largest price change when interest rates change. 3. a. Engage in active bond management, specifically bond swaps b. An intermarket spread swap should work. The trade would be to long the corporate bonds and short the treasuries. A relative gain will be realized when the rate spreads return to normal. 4. Change in Price = – (Modified Duration  Change in YTM)  Price =− Macaulay's Duration 1+ YTM  Change in YTM  Price Given the current bond price is $1,050, yield to maturity is 6%, and the increase in YTM and new price, we can calculate D: $1,025 – $1,050 = – Macaulay's Duration 1+ 0.06  0.0025  $1,050 x D = 10.0952 5. d. None of the above. 6. The increase will be larger than the decrease in price. 7. While it is true that short-term rates are more volatile than long-term rates, the longer dura ...
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