A bank has a portfolio of residential fixed interest mortgage bonds (bonds secured on residential mortgages) with a market valuation of €3mn, and with a modified duration of D = 7 years.
- State the duration formula describing the impact of a change of interest rates (Δi) on the value of this bond portfolio (P). Using this formula to estimate the impact of a rise of interest rates of 100 basis points on the value of this holding, in % and in €?
- Explaining your answers, provide two reasons why the actual impact might be different than this simple calculation.
- Briefly discuss the pros and cons of using a Value at Risk calculation, instead of duration, to describe the market risk of this portfolio of residential fixed interest mortgage bonds.
The question belongs to Finance and it discusses about duration formula describing impact of change in interest rates on the value of a bond portfolio.
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