Page 53 - PowerPoint Presentation
P. 53
LOS 36.k: Describe the use of one-sided durations READING 36: VALUATION AND ANALYSIS: BONDS WITH EMBEDDED OPTIONS
and key rate durations to evaluate the interest rate
sensitivity of bonds with embedded options.
MODULE 36.6: KEY RATE DURATION
Key Rate (partial) Duration (KRD)
Option-free bonds:
1. If trading at par, maturity-matched rate is the only rate that
2 affects its value. Maturity KRD = effective duration; all
others are zero.
3
2. If not trading at par, maturity-matched rate is still the most
important (15-year KRD is highest): Why? Need all CFs!
1
3. Bonds with zero/coupon rates < YTM can produce -negative
KRD for horizons < maturity. Negative? 15 years too soon!
Callable bonds:
4. Low coupon rates (< YTM), is unlikely to be called; hence,
maturity-matched rate is the most critical rate (i.e., the highest
KRD corresponds to the bond’s maturity, for 1% coupon 15-year
4 KRD exceeds all other key rate durations).
5. All else equal, higher coupon bonds are more likely to be called,
5 hence time-to-exercise rate will dominate the time-to-maturity
rate. For the 8% coupon bond, the 10-year KRD is highest.
Putable bonds:
6. High coupon rates (> YTM) are unlikely to be put, and thus
are most sensitive to their maturity-matched rates. For the 8%
bond, the 15-year KRD is the highest.
6 7. All else equal, lower coupon bonds are more likely to be put,
hence the time-to-exercise rate will dominate the time-to-
maturity rate. For the 1% coupon bond,
36.4, the 10-year KRD is highest.
