DV01 sounds like the name of a drone aboard a spaceship, but it stands for the "dollar value of 1 basis point." A basis point is equal to 0.01 per cent. An interest rate move from 8 per cent to 9 per cent is a 100 basis point move. DV01 is a common bond valuation calculation that provides a basis for comparing bonds based on changes in yield. As in most bond pricing relationships, a change in the positive/negative direction of a yield curve will produce a negative/positive reaction in price. The unknown is by how much.
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Define the DV01. The DV01 is the dollar change in the price of the bond if 1 basis point change in yield occurs. Therefore, we are looking for a price differential and need to calculate the bond price at two different yields. DV01 is also referred to as price value of a basis point (PVBP).
Define the variables. Let's assume we have a bond with a par value of £65, a coupon of 5 per cent, a maturity in five years, and an initial yield of 5 per cent. This bond is priced at par, £65.
Plug these variables into any financial calculator or spreadsheet for a bond or present value calculation. Again, the value of your bond (PV) is £65, the coupon is 5 per cent, the maturity (n) is 5 years, and the initial yield is 5 per cent. This means the bond is in parity. The price of a bond is the sum of the present value of all coupon payments plus the present value of the principal bond at maturity; that is, if you take the PV of the bond for Year 1 and add it to the present value for Year 2, and then add that to the present value of Year 3, Year 4, and Year 5, you will have the bond value. For bond pricing, the interest rate is the required yield. See Resources for a bond calculator.
Compute the price difference between a 1 basis point move downward and the current price. To compute, we take our example bond and reprice it after a -/+ basis point move down. Again, the dollar value of a basis point is equal to .01 per cent. A downward move is equal to 5.00 per cent minus .01 per cent, or 4.99 per cent. In order to get the new bond price at 4.99 per cent, we need to reprice our bond by inputing these new variables into the bond calculator.
Reprice the bond with a new yield equals current yield minus 1 basis point. If we decrease the yield to 4.99 per cent from 5.00 per cent, we have a new price of £65.028. The DV01 is the difference between £65.00 and £65.028, or $.0438. In words, the dollar value of a 1 basis point move is $.0438. Bonds with higher DV01s, within the same credit rating, are the better value.
Tips and warnings
- Don't construe these steps as investment advice.
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