TRADING CASE B04
Duration and bond immunization
LEARNING OBJECTIVE
Learn how duration can be used to reduce the effect of interest-rate changes on a bond position.
KEY CONCEPTS
Duration | Interest-rate risk | Parallel yield-curve shifts | Bond immunization
HOW THE CASE WORKS
You trade only on Day 1 of Year 1. You begin with a liability in one non-tradable security and may trade the two zero-coupon bonds. At year-end, your complete position is valued using the realized yield curve.
BOND PAYMENTS
| Security | Period 1 | Period 2 | Period 3 | Period 4 |
|---|---|---|---|---|
| Security 1 | 0 | 160 | 200 | 250 |
| Security 2 | 30 | 100 | 47 | 0 |
| 2-year zero | 0 | 100 | 0 | 0 |
| 3-year zero | 0 | 0 | 100 | 0 |
INTEREST RATES
The Year 1 spot rate is 25%. The starting yield curve is flat at 25%. At year-end, the curve remains flat but may move up or down by as much as 20 percentage points. Remaining cash flows are valued using the new rate.
TRADING RULES
- Only the 2-year and 3-year zero-coupon bonds can be traded.
- You may borrow cash and sell tradable securities short.
- If you are short, you must make any payment due on that security.
- Trader types begin with different liabilities, bond holdings, and cash.
AFTER TRADING CLOSES
Interest is applied to the closing money-market balance.
Any Period 1 security payments are made.
All remaining positions are valued using the realized year-end yield curve.
PERFORMANCE: Closing cash of 5,000 or less earns 0 grade cash; 9,999 or more earns 10. Intermediate balances earn a proportional amount. Results accumulate across trials.