Let us consider a bond with face value ($ 10,000), maturing in three years, and paying an
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Let us consider a bond with face value \(\$ 10,000\), maturing in three years, and paying an annual coupon at rate \(6 \%\). If annual yield is \(4 \%\), the bond price is
and its Macauley duration is
If yield does not change, we reinvest coupons at \(4 \%\), and sell the bond at time \(H=284\), wealth will be
To understand this expression, note that the first two cash flows are reinvested up to time \(t=2.84\), whereas the third cash flow is discounted from time \(t=3\) to \(t=2.84\). If yield is increased by 50 basis points, wealth will be
Indeed, up to an approximation error, future wealth at the right time horizon is insensitive to small changes in yield.
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Related Book For
An Introduction To Financial Markets A Quantitative Approach
ISBN: 9781118014776
1st Edition
Authors: Paolo Brandimarte
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