A newly issued bond has the following characteristics: a. Calculate modified duration using the information above. b.
Question:
a. Calculate modified duration using the information above.
b. Explain why modified duration is a better measure than maturity when calculating the bonds sensitivity to changes in interest rates.
c. Identify the direction of change in modified duration if:
i. The coupon of the bond were 4%, not 8%.
ii. The maturity of the bond were 7 years, not 15 years.
d. Define convexity and explain how modified duration and convexity are used to approximate the bonds percentage change in price, given a change in interestrates.
Coupon Yield to Maity Maturity Macaulay Duration 8% 15 years 10 years 8%
Step by Step Answer:
a Modified duration Macaulay duration1YTM 10108 926 years b For optionfree coupon bonds modified dur...View the full answer
Related Video
Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.
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