A better alternative to conventional bond in the context of risk management

Abstract

Under the assumption of flat spot curve, we define functional relationship between conventional and serial bonds’ prices, when the bonds’ parameters (par value, coupon rate and number of periods) are equal. Furthermore, we conduct a thorough study of joint behavior of conventional and serial bonds’ durations, which suggests that if spot curve is flat, and the bonds’ parameters (coupon rate and number of periods) are equal, then conventional bond’s durations (Macaulay and modified) significantly exceed serial bond’s durations. That is, all things being equal, conventional bond has considerably greater weighted average time until repayment and is much more exposed to interest rate risk than serial bond.