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Postby shah.vishal » Sun May 12, 2013 9:35 pm

A portfolio manager has a bond position worth USD 100 million. The position has a modified duration of 8 years and a convexity of 150 years. Assume that the term structure is flat. By how much does the value of the position change if interest rates increase by 25 basis points?
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Postby vnraghuveer » Tue May 14, 2013 10:10 am

The combined effect of duration and convexity gives us the approximate change in price of the portfolio with a given change in yield. The formula is given below:

Change in value = ( -ΔY x duration) + (1/2 x Convexity x 〖(ΔY)〗^2 )
= (-0.0025 x 8) + (1/2 x 250 x (0.0025)^2) = -0.01922 = -1.92 %.
i.e. 1.92% decrease in the value of the portfolio

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