A bond has a par value of $1000. The yield to maturity is 2% annually. The bond
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Question:
A bond has a par value of $1000. The yield to maturity is 2% annually. The bond pays a $20 coupon annually. The maturity of the bond is 5 years, in the end of which the bond pays back the par value. (a) What is the price of the bond?
(b) What are the duration and the modified duration of this bond?
(c) If the yield increases from 2% to 2.1%, what is the price change based on modified duration?
(d) What is the actual price change? [Hint, recalculate the price of the bond using 2.1% yield].
(e) Do (c) and (d) differ a lot?
(f) Repeat (c)-(e), assuming that the yield increased from 2% to 4%.
(g) Can you reliably rely on the (modified) duration method to estimate price changes when the yield moves a lot? Why?
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