Chapter 11 - Duration, Convexity and Immunization

Chapter 11 - Duration, Convexity and ImmunizationSection - DurationConsider two opportunities for an investment of $1, : Pays $610 at the end of year 1 and $1,000 at the end of year 3B: Pays $450 at the end of year 1, $600 at the end of year 2 and$500 at the end of year have a yield rate ofi=.25 because( ) 1=.8,1000= (.8)(610) + (.8)3(1000)and1000= (.8)(450) + (.8)2(600) + (.8)3(500).11-1 The repayment patterns of these two investments are quite differentand we seek to compare them on the basis of the timing of therepayments. Getting the repayments sooner would be advantageousif reinvestment yield rates are above the current yield of thisinvestment (in the above settingi=.25), whereas delaying therepayments is advantageous if the reinvestment interest rates arelower than the current yield of Equated Time (See section ) provides a simple answerto measure the timing of the repayments:HereRtdenotes a return (Rt>0 is a payment back to the investormade at timet).

With continuous compounding at a constant force of interest , d = = P n t=1 te tR t (P n t=1 e tR t) that is, Macaulay duration and modified duration are the same. See pages 455-456 in the textbook. - - - - - - - - - - - Example: Consider azero coupon bondthat makes one payment of C at the end of n periods, with a effective interest rate of i ...

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