Price value of a basis point (PVBP) Fixed Income Securities

LOS

69.i. compute the price value of a basis point (PVBP), and explain its relationship to
duration.


What is basis point value, (BPV)?

BPV is a method that is used to measure interest rate risk. It is sometimes referred to as a delta or DV01. It is often used to measure the interest rate risk associated with swap trading books, bond trading portfolios and money market books.

It is not new. It has been used for years. In many financial institutions it has been replaced or is used in conjunction with value at risk.

What does it show?

BPV tells you how much money your positions will gain or lose for a 0.01% parallel movement in the yield curve. It therefore quantifies your interest rate risk for small changes in interest rates.

How does it work?

Let's suppose you own a $10m bond that has a price of 100%, a coupon of 5.00% and matures in 5 years time. Over the next 5 years you will receive 5 coupon payments and a principal repayment at maturity. You can value this bond by:

A. Using the current market price from a dealer quote, or

B. Discounting the individual bond cash flows in order to find the sum of the present values

Let's assume you use the second method. You will use current market interest rates and a robust method for calculating accurate discount factors. (Typically swap rates are used with zero coupon methodology).

For the sake of simplicity we will use just one interest rate to discount the bond cash flows. That rate is 5.00%. Discounting the cash flows using this rate will give you a value for the 5 year bond of $10,000,000. (How to do this using a financial calculator is explained on the second page of this document).

We will now repeat the exercise using an interest rate of 5.01%, (rates have increased by 0.01%). The bond now has a value of $9,995,671.72.

There is a difference of $4,328.28.

It shows that the 0.01% increase in interest rates has caused a fall in the value of the bond. If you held that bond you would have lost $4,328.28 on a mark-to-market basis.

This is the BPV of the bond.

For some more details see
http://www.barbicanconsulting.co.uk/quickguides/bpv