Reading 59: Curve-Based and Empirical-Income Risk Measures

Book 3: Fixed Income

Value of a callable bond =

equivalent straight bond + short call option

Value of Putable Bond =

straight bond + long put option

What’s the issue with valuing price changes in bonds with embedded options?

they don’t have a defined YTM

need to use the benchmark yield curve to value

Effective Duration

measuring interest rate risk based on shifts in the benchmark curve

Which bond can exhibit negative convexity?

callable bond

at low yields, the option becomes more valuable and effectively puts a price limit on increases in bond value

The duration of a callable bond is more/less than that of an equivalent option bond at low yields?

less

Key Rate Duration

the sensitivity of the value of a bond or portfolio to changes in the benchmark yield for a specific maturity holding other yields constant

In the context of key rate durations, the effective duration is equal to

the sum of the key rate durations

Shaping Risk

the effect of a nonparallel shift in the yield curve on a bond portfolio