Duration and Interest Rate Risk

Describe the relationship between duration and bond price sensitivity. Which bond has a longer duration at a YTM=8%: a 15-year zero coupon or a 30-year 8% coupon? Explain. Use duration to describe the risk involved in the Bob Citron carry trade example we covered in the handout provided in class. 30 yr 8% coupon Because when we have a larger coupon and lower year to maturity = low duration

Name and describe the two sources of interest rate risk. If an investor has a desired investment horizon (or holding period) of 5 years, and is invested in 20-year 6% coupon bonds priced to yield 6%, what bet is he or she making about the direction of interest rates? Compute the 5-year holding period yield assuming that interest rates rise to 8% immediately after the bond is purchased. Explain how this investor could immunize against interest rate risk. Two sources are price risk, if duration is greater than invest horizon and Reinvestment Risk if duration is less than invest horizon.

Which institutional investors are natural buyers of long-duration bonds? Explain why using your understanding of duration and immunization.. The Natural buyers are Mutual funds,

Describe the behavior of credit spreads over the business cycle. Why do credit spreads tend to widen during a falling rate environment? If you think the economy will strengthen unexpectedly how would you alter the 1) duration of your portfolio (explain why) and 2) credit quality of your portfolio. When the economy strengthen spread decreases then low grade and low rated bonds.