Introduction

Understanding the concept of DV01 (Dollar Value of 01) is crucial for assessing the sensitivity of bond prices to changes in yields. DV01 measures the change in the market value of a fixed income security resulting from a one-basis-point (0.01%) change in yield. This chapter explores the fundamentals of DV01, its calculation, and its significance in fixed income analysis.

DV01

DV01, also known as the price value of a basis point (PVBP) or dollar price value of an 01 (DPVO1), is a measure of interest rate risk. It represents the amount in dollars that a bond’s price will change for a 1-basis-point change in yield. In essence, it quantifies the bond’s sensitivity to interest rate fluctuations. A higher DV01 implies greater price sensitivity to interest rate changes, making the bond riskier.

Calculating DV01

The formula for calculating DV01 is given below:

$$DV01=\frac{dP}{dy}$$

Where:

• $DV01$: Dollar Value of 01 (in dollars)
• $dP$: Change in the bond’s price (in dollars)
• $dy$: Change in yield (in decimal form)

To calculate $dP$, you subtract the bond’s price after a yield change from its initial price. $dy$ represents the change in yield, expressed as a decimal (e.g., a USD 0.01% change is represented as 0.0001 in the formula).

Example: Let’s say you have a bond with an initial price of USD 1,000 and a yield of 5%. If the yield increases by 0.01% (0.0001 in decimal form), the bond’s price falls to USD 990.

Using the formula:

$$DV01=\frac{(1000-990)}{0.0001}=\text{USD 10,000}$$ So, the DV01 for this bond is USD 10,000. This means that for every 1-basis-point increase in yield, the bond’s price decreases by USD 10.

Significance of DV01

DV01 is an essential tool for managing interest rate risk in fixed income portfolios. It helps portfolio managers and investors assess the potential impact of interest rate changes on bond prices. By calculating the DV01 for each bond in a portfolio, one can estimate the overall portfolio’s sensitivity to interest rate movements.