DV01

DV01 - Dollar Value of a One-Basis Point Decrease Summarization

DV01 is a method of measuring a bond's price sensitivity to price change based on changes in interest rates. A DV01 other than zero implies the bond has exposure to interest rate risk, which is defined as: "The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. Such changes usually affect securities inversely and can be reduced by diversifying (investing in fixed-income securities with different durations) or hedging (e.g. through an interest rate swap). "1

At an individual DV01 level, the higher the DV01 the more exposure to interest rate risk. Although risky investments tend have a higher level of return, many use DV01 as a hedging tool, which is driven toward reducing risk in an investment.

The are three methods to calculating DV01 with some being more accurate than others. One key thing to remember is that a Basis Point is the equivalent of "1/100th of 1 percent."2

  1. Price at a Yield One Basis Point below existing yield less price
  2. First Derivative of the price yield
  3. Price at a Yield 1/2 Basis Point Below Less Price at 1/2 Basis Point above existing yield3

Once DV01 has been calculated, the value can be used to calculate the change in price using DV01 and the change in Basis point.

(1)
\begin{align} \delta\ P = -DV01 - \delta\ bp \end{align}
4

It's also possible to calculate the DV01 at a portfolio level. This is accomplished by summing the DV01 for each individual bond. The goal here is to have a portfolio DV01 of zero or as close to zero as possible, which implies that any changes in interest rate will not have an affect on a bond's price.