NISM Series XV : Research Analyst Certification Exam Notes
Page 28 Of 62
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Higher the time to maturity, higher the duration and hence higher the interest rate risk of the bond. Lower the coupon rate, higher the duration and hence higher the interest rate risk of the bond. And, Lower the yield, higher the duration and hence higher the interest rate risk of the bond.
Modified Duration (M Duration) - Modified Duration measures the impact of changes in interest rates on the price of the bond. While Duration gives us sensitivity of bond prices to change in interest rates, Modified Duration gives us the magnitude of this change. M Duration = - Duration/ (1 + YTM)
Convexity - The impact of change in interest rates on bond prices is inverse but not linear. This means when rates go up, bond prices go down; but they don't fall as much as they would rise when rates go down by the same magnitude.
Zero-Coupon Bond - Bonds which do not pay coupon in their entire term are known as Zero Coupon Bonds or simply 'Zeroes'. Such bonds are issued at a discount to their face values and are redeemed at par. Thus, the return on these bonds is not in the form of periodic payment of interest but in the form of difference between the issue price and redemption value.
Floating - Rate Bonds - These are bonds whose coupon is not fixed, as in the case of vanilla bonds, but is reset periodically with reference to a defined benchmark. This could be the inflation index or interbank rates or call rates or some other relevant benchmark. Resetting the coupon periodically ensures that these bonds pay interest that reflect current market rates. Due to their unique nature of constant adjustment of coupon rates, these bonds carry lower interest rate risk or 'price risk'.
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