Bonds: Simplified
The price and yield relationship
Bond prices and yields move in opposite directions because existing cash flows are discounted at the new market rate. A higher discount rate lowers present value. A lower discount rate raises present value.
Why duration is only a first pass
Modified duration is a useful first-order estimate for small moves. Larger shocks need convexity. Bonds with embedded options, including callable bonds and MBS, need scenario-based measures such as effective duration because their expected cash flows can change when rates move.
Rate shocks in MBS
MBS analysis adds prepayment behavior to the rate move. A down-rate shock can increase refinancing incentive and speed prepayments. An up-rate shock can slow prepayments and extend the security. Bonds: Simplified shows these scenarios across price, yield, WAL, Treasury spread, and prepayment speed.
Common shock ranges
Scenario tables often show a range such as -300 to +300 basis points around the base case. The goal is not to forecast one future path. It is to see how sensitive valuation and cash flow timing are to different market-rate environments.