Assume you buy a 5-year 10% annual bond which is priced to yield 14%. face value

Question

Assume you buy a 5-year 10% annual bond which is priced to yield 14%. face value is 1000. Calculate the following items.

1. Determine the current price of the bond.

2. Determine the bond’s Macaulay Duration (D).

3. Determine the bond’s Modified Duration (Dmod). Interpret this value.

4. Given the price you calculated in part 1 above, if open market interest rates are expected to drop by 75 basis points in the immediate future (from 14% down to 13.25%), determine:

a. The percentage (%) change in price this bond can expect to realize when this change in yields occurs.

b. The approximate dollar ($) value change [plus or minus] this bond can expect to see with this change in open market rates.

c. The approximate new price this bond can expect to sell for after the change in open market yields.

Explanation / Answer

Ans

Ans 2&3

Ans 3 1% change in YTM will cause 3.6% inverse change in bond value.

Ans 4

Details Amount Maximum Price=Current Market Price Current Market Prize= sum total of Present Value of coupon payments and face value at end of maturity period discounted at YTM Maturity Period in years 5 Annual coupon rate 10% Annual YTM 14% Face Value Market Value=(C*(1-(1+YTM)^-5)/1+YTM)+FV*1+YTM^-5                862.68 Where C=Coupon Amount PA YTM Annual YTM FV=Face Value

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