A bond has a $1,000 par value and an 11 percent coupon rate, two years remaining

Question

A bond has a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity.
(1) If the bond pays coupon annually, what is the duration of this bond and modified duration of the bond?
(2) If the bond pays coupon semi-annually, what is the duration of this bond?
(3) Based on your answer in part (1), assume that bond yields rise by 0.50%, what is an estimate of the percentage drop in the bond’s price?
(4) What is the potential problem of using modified duration in estimating bond price changes to interest rate changes?

Explanation / Answer

ANSWER:    

Because of the symmetry of the t distribution, this left-hand tail probability can be calculated exactly like right-hand tail. The answer is 0.22119.

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