Problem:
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.
Additional Information:
This question is basically belongs to the Finance as well as it explains about duration formula describing impact of change in interest rates on the value of a bond portfolio.