Interest Theory and Bond Math

Yield curves, duration, convexity, immunization, and bond portfolio management.

Key Concepts

• •Yield curves: construction from bond prices, bootstrapping spot rates
• •Forward rates: implied future interest rates from the current term structure
• •Macaulay duration: weighted average time to cash flows
• •Modified duration: price sensitivity to yield changes
• •Effective duration: duration for bonds with embedded options
• •Convexity: second-order measure of price sensitivity
• •Immunization: matching duration and convexity to protect against rate changes
• •Redington immunization: conditions for immunizing a surplus
• •Full immunization: conditions for absolute protection against any rate change
• •Key rate duration: sensitivity to individual points on the yield curve

Study Tips

• 1.Practice bootstrapping spot rates from par bond yields.
• 2.Understand the relationship between Macaulay and modified duration.
• 3.Work through immunization problems with specific cash flow patterns.
• 4.Know when Redington immunization protects and when it does not.
• 5.Practice bond pricing problems with different coupon structures and yields.

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