Académique Documents
Professionnel Documents
Culture Documents
Vinay P NUNDLALL
Problem Set 4 Solutions
Question 1
BKM 9th Ed, Chapter 16, Problems 3
BKM 7th Ed, Chapter 16, Problems 1
BKM 8th Ed, Chapter 16, Problems 3
A 9 year bond has a yield of 10% and a duration of 7.194 years. If the
market yield changes by 50 basis points, what is the percentage
change in the bonds price?
50 basis points is equivalent to 0.5% or 0.005.
proportionate price change and duration is:
P
1 y
7.194
D
0.005 0.0327
P
1 y
1.1
That is, if the yield increases by 0.5 %, the price of the bond will fall by 3.27%.
Question 2
BKM 7th Ed, Chapter 16, Problems 2
BKM 8th Ed, Chapter 16, Problems 4
Find the duration of a 6% coupon bond making annual coupon
payments if it has 3 years until maturity and a yield to maturity of 6%.
What is the duration if the YTM is 10% instead?
T
D wt t
t 1
CFt
(1 y t ) t
wt
60
60
1,060
1
2
3
1
2
3
(1 0.06)
(1 0.06)
(1 0.06)
2.83
1,000
Par
YTM
1,000
0.06
Coupon
Rate
CFt
Pmt
Cash
Year Period
Flow
1
1
60
2
2
60
3
3
1060
Bond
Price =
0.06
CFt
(1 yt )t
t1
1.0000
2.8334
1,060
60
60
1
2
3
1
2
3
(1 0.1)
(1 0.1)
(1 0.1)
2.82
900.53
D wt t
1000
Duration
0.0566
0.1068
2.6700
Weight
0.0566
0.0534
0.8900
CFt
(1 y t ) t
wt
PV of CF
56.6038
53.3998
889.9964
CFt
t
(1
y
)
wt
Par
YTM
1,000
0.1
Coupon
Rate
CFt
0.06
Year
1
2
3
CFt
(1 yt )t
Pmt
Perio
d
1
2
3
Cash
Flow
60
60
1060
Bond
Price =
CFt
t
(1
y
)
wt
D wt t
t1
PV of CF
54.5455
49.5868
796.3937
Weight
0.0605
0.0551
0.8844
Duration
0.0605
0.1101
2.6531
900.5260
1.0000
2.8237
Question 3
There are two bonds available: Bond A that pays a semi-annual coupon
at a rate of 4% per annum and matures in 4 years;
Bond B that pays a semi-annual coupon at a rate of 7% per annum and
matures in 4 years.
The yield curve is flat at 6% per annum.
a) Calculate the duration of each bond.
How does coupon rate affect duration?
Bond A has a duration of 3.72 years and Bond B has a duration of 3.57
years.
As coupon rate increases, ceteris paribus, duration decreases.
b) If the interest rates change to 6.25%, what are the prices of the
bonds?
What are the prices if interest rates change to 7.50% instead?
When rates increase to 6.25%, the change in rate = +0.25% =
+0.0025
Bond A:
P
1 y
3.72
D
0.0025 0.0088
P
1 y
1.06
0.0025 0.0084
P
1 y
1.06
P = 1,035.10 x (1 0.0084) =1,026.38
When rates increase to 7.5%, the change in rate = +1.5% = +0.015
Bond A:
P
1 y
3.72
D
0.015 0.0526
P
1 y
1.06
P = 929.80 x (1 0.0526) = 880.85
Bond B:
P
1 y
3.57
D
0.015 0.0505
P
1 y
1.06
P = 1,035.10 x (1 0.0505) =982.81
Question 4
BKM 9th Ed, Chapter 16, Problems 14
BKM 7th Ed, Chapter 16, Problems 14
BKM 8th Ed, Chapter 16, Problems 12
1 ytm 1 0.05
ytm 0.05 21
After one year the zero has a maturity of only 4 years. The perp. however still
has a maturity of 21 years. The initial portfolio has a duration of 9 years so
using the same notation as earlier:
(w x 4) +[(1 w) x 21] = 9
w = 12/17 or 0.7059
(1 w) = 5/17 or 0.2941
In order to match the duration of our initial portfolio, we increase investment
to 12/17 of our wealth in the zero and decrease investment to 5/17 in the
perp.