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Don’t understand below:
Duration is only useful in assessing small change in interest rates. Ths is because although as interest rates increase, bond prices will fall (and vice versa) the relationship is non-linear. In fact, the relationship between the changes in bond values and changes in interest rates is in the shape of a convex curve.Its because the duration is assuming linearity when the relationship is actually a curve.
For small changes, the difference between the curve and a straight line will be only small, but for big changes it starts to make a big difference.Why are the bonds due to be redeemed at a later date are more price sensitive to interest rate changes, pls?
It is because the market value is the present value of the receipts discount at the investors required return. If the required return changes (because of general interest rate changes) then obviously the market value changes.
The longer the period to redemption, the bigger percentage change there will be in the market value if the required return changes.
The best way of seeing exactly what I mean is to work through examples 2, 3 and 4 in Chapter 8 of the course notes. They are very tiny examples but it should make the point clear.
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