Page 29 - PowerPoint Presentation

LOS 34.l: Explain how a bond’s exposure to each of the
factors driving the yield curve can be measured and how these
exposures can be used to manage yield curve risks. Session Unit 16:
54. Understanding Fixed Income Risk and Return
REVIEW FROM CFA LEVEL 1

LOS 54.d: Define key rate duration and describe the use of key rate durations in measuring the sensitivity of bonds to changes in
the shape of the benchmark yield curve., p. 108
A key rate duration (also known as a partial duration) is the sensitivity of the value of a bond (or portfolio) at a specific
maturity point along the entirety of the yield curve to changes in the spot rate (zero coupon or treasury yield curve),
holding other spot rates constant.
• Measures the effect of a nonparallel shift in the yield curve on a bond portfolio.
• Measure the sensitivity in a bond's price to a 1% change in yield for a specific maturity.

tanties

As an example, assume that a bond is originally priced at $1,000, with a 1% increase in
yield would be priced at $970, and with a 1% decrease in yield would be priced at $1,040.
The key rate duration for this bond would be:

For example, assume bond X
has a one-year key rate duration
P(0) = Vo = Original price of the bond of 0.5 and a five-year key rate
P(-) = V- = Bond price with a 1% - in yields
P(+) = V+ = Bond price with a 1% + in yields duration of 0.9. Bond Y has key
rate durations of 1.2 and 0.3 for
these maturity points. It could be
Key rate duration =
said that bond X is half as
sensitive as bond Y on the
($1,040 - $970) / (2 x 1% x$1,000) =
short-term end of the curve,
$70 / $20 = 3.5 while bond Y is one-third as
sensitive to interest rate
changes on the intermediate
part of the curve.