Page 23 - FINAL CFA SLIDES DECEMBER 2018 DAY 15

LOS 54.j: Describe how the term structure of Session Unit 16:
yield volatility affects the interest rate risk of a 54. Understanding Fixed Income Risk and Return
bond., p.115

The term structure of yield volatility refers to the relation between the volatility of bond yields and their
times to maturity.

Although the sensitivity of a bond’s price with respect to a given change in yield depends on its duration
and convexity, from an investor’s point of view, it’s the volatility of a bond’s price that is of concern.

The volatility of a bond’s price has two components:
tanties

• the sensitivity of the bond’s price to a given change in yield; and
• the volatility of the bond’s yield.

In calculating duration and convexity, we implicitly assumed that the yield curve shifted in a parallel
manner. In practice, this is often not the case. For example, changes in monetary policy may have more of
an effect on short-term interest rates than on longer-term rates.

It could be the case that a shorter-term bond has more price volatility than a longer-term bond with a
greater duration because of the greater volatility of the shorter-term yield.