Understanding Fixed-Income Risk and Return for the CFA Level 1 Exam

Welcome to the exciting world of fixed-income risk and return! In this article, we’ll journey through the various factors that impact fixed-income investments and the tools used to assess and manage their risks. Ready to bond with this essential topic? Let’s go!

Sources of Return

Dive headfirst into the thrilling world of fixed-rate bonds! In this lesson, we’ll unravel the mysteries of return sources, including coupon and principal payments, reinvestment returns, and potential gains or losses from the bond’s sale. We’ll explore how different factors, like prevailing interest rates and the bond’s credit quality, can influence these returns. We’ll contrast the impacts on buy-and-hold investors and bond traders, giving you a comprehensive understanding of these concepts.

► Eager to get to grips with fixed-rate bonds? Explore further here.

Macaulay Duration

Get set to master Macaulay duration! This concept is pivotal to understanding a bond’s reaction to interest rate changes, and you’ll learn exactly how to calculate it. Furthermore, you’ll discover the importance of the duration gap, which is the difference between the Macaulay duration and the investor’s investment horizon, and its effects on investment returns.

► Eager to take on Macaulay duration? Keep learning here.

Modified Duration and Money Duration

Prepare to explore the intricacies of bond duration! This lesson introduces modified duration, which predicts a bond’s price shift in response to a 1% yield-to-maturity change, and money duration, which calculates the absolute price change in currency units. Also, you’ll learn about Price Value of a Basis Point (PVBP), a measure that gauges a bond’s full price change for a 1 basis point shift in yield.

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Approximate Modified Duration and Convexity Adjustment

Dive deep into the world of approximate modified duration and convexity adjustment! In this lesson, you’ll learn how these two calculations help you estimate changes in bond price due to shifts in yield-to-maturity more accurately. Plus, you’ll discover how to gauge the influence of individual yield components on bond prices.

► Ready to sharpen your skills in bond price estimation? Keep learning here.

Effective Duration and Key Rate Duration

This lesson dives into the deep end of duration measures, introducing you to the concepts of effective duration and key rate duration. You’ll learn how effective duration uncovers a bond’s sensitivity to changes in the benchmark yield curve, and why it’s crucial for bonds with embedded options. Key rate duration, on the other hand, helps estimate how a bond’s price changes under various yield curve scenarios.

Duration of a Bond Portfolio

This lesson embarks on the journey of calculating the duration of a bond portfolio. You’ll explore two key methods: the Aggregated Cash Flows Approach, which treats the portfolio as one big bond with multiple cash flows, and the Weighted Average Method, which calculates the duration based on each bond’s weight in the portfolio. Both come with their unique sets of advantages and limitations.

► Ready to crack the code of bond portfolio durations? Venture forth here.

Factors that Influence Interest Rate Risks

In this lesson, we delve into the factors that contribute to a bond’s interest rate risk. You’ll learn about the three main properties at play: time to maturity, coupon rate, and yield-to-maturity. How these aspects affect the Macaulay duration will be uncovered, along with the impact of yield volatility on the bond’s price.

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Empirical Duration

In this session, you’ll unravel the difference between empirical and analytical duration. The focus is on how these durations measure the sensitivity of a bond’s price to changes in interest rates, with an extra spotlight on corporate bonds. You’ll understand how analytical duration might fall short due to fluctuating credit spreads, and why empirical duration can provide more accurate estimates.

► Eager to dive into the world of empirical and analytical duration? Get started here.