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CMA Final · Risk Management in Banking and Insurance · Interest Rate Risk Management

A bank holds a bond portfolio with a market value of Rs 500 crore and a modified duration of 4.2 years. If yields rise by 50 basis points, what is the approximate change in the portfolio's market value using modified duration?

The portfolio value falls by about Rs 10.50 crore. Price change is approximately minus modified duration times the yield change times value, so 4.2 times 0.5 percent times Rs 500 crore gives Rs 10.50 crore. Bond prices move inversely to yields, so the value declines when yields rise.

  1. ADecrease of Rs 10.50 croreCorrect
  2. BIncrease of Rs 10.50 crore
  3. CDecrease of Rs 21.00 crore
  4. DDecrease of Rs 4.20 crore

Explanation

Change in value is approximately -ModifiedDuration x change in yield x value = -4.2 x 0.005 x 500 = -10.50 crore. The Rs 21 crore option wrongly treats 50 bps as 1 percent. The increase option ignores the inverse relationship between yield and price. The Rs 4.20 crore option is a meaningless use of the duration figure alone.

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