Kirstin Brown is a portfolio manager at Standard life plc. She wants to estimate the interest rate riskof assets of the company consisting of 1 million shares of Bond A, 2 million shares of Bond B, and 2million shares of Bond C. The duration of Bond A is 5.59, a valuation model found that if interest ratesdecline by 30 basis points, the value of Bond A will increase to 83.5 pounds, and if interest ratesincrease by 30 basis points, the value of Bond to A will decline to 80.75 pounds. The same valuationmodel also found that if interest rates decreases by 50 basis points, the value of Bond B increases to104.6 pounds, and if interest rates increases by 50 basis points, the value of Bond B decreases to 96.4pounds, and the current value of Bond B is 100 pounds. Kirstin also knows from the valuation modelthat, by using the duration and convexity rule, if interest rates decline by 1%, the price of bond Cincreases approximately by 8.46 pounds, and if interest rates increase by 3%, the price of Bond Cdecreases approximately by 12.77 pounds. The convexity of Bond C is 300.a ) What is current value of the bond portfolio?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Kirstin Brown is a
of assets of the company consisting of 1 million shares of Bond A, 2 million shares of Bond B, and 2
million shares of Bond C. The duration of Bond A is 5.59, a valuation model found that if interest rates
decline by 30 basis points, the
increase by 30 basis points, the value of Bond to A will decline to 80.75 pounds. The same valuation
model also found that if interest rates decreases by 50 basis points, the value of Bond B increases to
104.6 pounds, and if interest rates increases by 50 basis points, the value of Bond B decreases to 96.4
pounds, and the current value of Bond B is 100 pounds. Kirstin also knows from the valuation model
that, by using the duration and convexity rule, if interest rates decline by 1%, the price of bond C
increases approximately by 8.46 pounds, and if interest rates increase by 3%, the price of Bond C
decreases approximately by 12.77 pounds. The convexity of Bond C is 300.
a ) What is current value of the bond portfolio?
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