BOND PRICE VOLATILITY
Economist Omar Venerio
Professor of Finance
A fundamental propertyof a bond is that its price will change in the opposite direction from the change in the required yield for the bond:
Price of a Bond
P = price
n =number of periods (number of years x 2)
CF = semiannual coupon payment (in $)
r = periodic interest rate (required annual yield / 2)
Ideally, a portfolio manager would like a measure thatindicates the relationship between changes in required yields and changes in a bond´s price.
FACTORS THAT AFFECT A BOND´S PRICE VOLATILITY
1) The effect of the Coupon Rate
The lower thecoupon rate, the greater the price volatility of a bond.
2) The effect of Maturity
The longer the maturity, the greater the price volatility of a bond.
3) Effects of Yield to Maturity onPrice Volatility
Price volatility is greater when yield levels in the market are low, and price volatility is lower when yield levels are high.
MEASURES OF PRICE VOLATILITY
Price Value of abasis point (PVBP) or Dollar Value of an 01 (DV01)
Measures the change in the price of a bond if the required yield changes by one basis point. This measure of price volatility is in terms ofdollar price change.
This measure is derived using calculus. The change in the value of a mathematical function can be estimated by taking the first derivative of that function:dp = - CF1 + - 2 CF2 + - 3 CF3 + ......... + - n CFn
___________ ____________ ____________ ________________________
dr (1+r)2 (1+r)3 (1+r)4 (1+r)n+1
If we divided the equation by the initial price:...
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