ABSTRACT
The objective of this chapter is to make the readers aware about bond price sensitivity to change in interest rates, and different measures available to capture such interest rate sensitivity. Since institutional investors are majorly exposed to the interest rate risk, due to their broader nature of investments, it is very crucial for a bond portfolio manager to successfully measure and manage the interest rate risk present in portfolio. At the end of this chapter, the readers are expected to be familiar with:
How the prices of different bonds respond to a change in interest rate?
What are the different measures available to capture interest rate sensitivity?
What is Duration, M-Duration, PV01/PVBP, and how these are estimated for a single security?
How to estimate the interest rate sensitivity of a portfolio of various securities?
How to captures the IR sensitivity of bonds with embedded options, and how such measure is different from the sensitivity measures applicable to option-free securities?
What are the usefulness and limitations of various IR sensitivity measures?
What is Convexity, and how the same is captured?
Whether Convexity truly supplements the M-Duration measure to capture bond price sensitivity to interest rates?
How these sensitivity measures are practically used to successfully manage a bond portfolio of an institutional investor?
