Mark Freeland
Guest
|
 Posted:
Sun Nov 13, 2005 5:00 pm Post subject:
Re: Inflation protected bonds |
|
|
darkness39 wrote:
| Quote: |
Is the other difference a fund keeps buying and selling bonds to
maintain a certain duration?
Whereas holding a single bond, your duration is always falling (as you
get closer to maturity)?
|
That's not necessarily true with callable bonds. A common example, that
people really should understand better, is a mortgage-backed security
(i.e. bond) - MBS (e.g. GNMA, CMO, etc.)
As interest rates rise, people will hold onto their fixed rate mortgages
longer - if you had a mortgage that was 1% above the going rate, you
might refinance, but if you had a mortgage that was 1% below the going
rate (because rates were rising), you'd hold it longer; you'd also be
less inclined to prepay. So the expected "maturity" of the bond
increases as rates increase, extending the duration for awhile, as time
passes.
On the other hand, if the mortgage is an adjustable rate mortgage, then
the coupon will drop as interest rates drop. This also increases the
duration, because while the payment schedule remains the same, fewer
dollars are paid monthly (in the extreme, if the interest rates went
down to zero, you'd have a zero coupon bond - so you can see that
falling rates increase duration). So here too, there is a period of
time when rates change (fall) and duration increases.
I'm not even going to get into interest only (IO) bonds and negative
convexity (where the second derivative of price vs. rates is negative).
http://www.investopedia.com/university/advancedbond/advancedbond6.asp
(very clear discussion of convexity)
http://www.investopedia.com/university/advancedbond/advancedbond5.asp
(same site explaining duration)
http://pages.stern.nyu.edu/~igiddy/ABS/absmbs.pdf
(Stern School slide presentation on mortgage backed securities also
going into convexity, duration, etc.)
--
Mark Freeland
nNeEwTs@sonic.net
|
|
Mark Freeland
Guest
|
| Posted:
Sun Nov 13, 2005 11:15 pm Post subject:
Re: Inflation protected bonds |
|
|
I wrote:
| Quote: |
On the other hand, if the mortgage is an adjustable rate mortgage, then
the coupon will drop as interest rates drop. This also increases the
duration, because while the payment schedule remains the same, fewer
dollars are paid monthly (in the extreme, if the interest rates went
down to zero, you'd have a zero coupon bond - so you can see that
falling rates increase duration).
|
Since mortgage payments typically include principal, even with a zero
percent rate, a mortgage would not be equivalent to a zero. So it is a
bit more complex. Rather than going into the calculations, suffice to
say that changing rates will affect the duration, so we may reasonably
conclude that there is a direction of rate change (either up or down)
that increases the duration - thus duration can increase for some finite
periods of time (as interest rates shift).
--
Mark Freeland
nNeEwTs@sonic.net |
|
FAQ
Memberlist
Register
Profile
Log in to check your private messages
Log in