Page 202 - A Canuck's Guide to Financial Literacy 2020

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N = 20
I = 10
• PV of interest payments = $1,869.33
• Purchase Price = 1884.44 + 1,869.33 = 3,753.77

Since $3,753.77 is less than $5,000 which is the maturity value, you can say that this bond
was purchased at a discount.

We’ve broken it down to 2 steps but if you wanted, you can calculate everything in one step
using a financial calculator.

• P/Y = 2
C/Y = 2
FV=$5,000
PMT = $150 (0.06/2) x $5,000
N= 10 X 2 = 20
I/Y = 10
• Purchase Price = $3,753.77

Bond Duration

When you’re reading about bonds, it’s almost impossible to not come across the word
“duration”. What does it mean and how does it affect your portfolio?

Now that we’ve read about bond prices and their inverse relationship with interest
rates, we can talk about duration. Duration is measured in years and is the approximate
measure of a bond’s price sensitivity to changes in interest rates. It calculates how long it
will take an investor to be repaid the bond’s price by the bond’s cash flows (coupons). The
higher the duration of a bond, the more its price will drop as interest rates rise. (the greater
the interest rate risk)

How Duration Works

For every 1% increase or decrease in interest rates, a bond’s price will change 1% in the
opposite direction for every year of duration. For example, if a bond has a duration of five
years and interest rates increase by 1%, the bond’s price will decline by 5%. Alternatively, if
a bond has a duration of 5 years and interest rates fall by 1%, the bond’s price will increase
by approx. 5%.

How Duration Helps Your Portfolio

Duration is a way for you to compare bonds and adjust accordingly in your investment
portfolio.