a) Define the determinants of duration. b) In which cases is duration sufficient to give us...

a) Define the determinants of duration.

b) In which cases is duration sufficient to give us an accurate result of a bond price alteration? Why?

Expert Solution

Define the determinants of duration

Duration is determined by

Maturity of a Bond, or period in which Coupon is received
Yield to Maturity
Maturity Value
If time to maturity and yield to maturity are constant, duration is higher when coupon rates are lower.
With coupon rates constant and time to maturity is longer, duration is higher.
Duration is higher when the yield to maturity is lower and duration is lower when yield to maturity is higher.

In which cases is duration sufficient to give us an accurate result of a bond price alteration? Why?

Bond price is inversely co-related with Duration, and hence as the interest rate increases, bond yield increase and bond price decrease.

However, duration is not a perfect way to measure a bond’s price change, as it indicates linear change, which is not the case and it exhibits a sloped or convex shape, which is called as convexity.

A bond is said to have positive convexity if duration rises as the yield declines.

In small change of rate, such as 1 basis point, convexity does not play important role and hence duration is sufficient to give us an accurate result of a bond price change.

jeff jeffy answered 1 year ago

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a) Define the determinants of duration. b) In which cases is duration sufficient to give us...

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