You own the following $1,000 bonds: Bond A .... 4 percent coupon due in three years Bond

Question:

You own the following $1,000 bonds:

Bond A .... 4 percent coupon due in three years

Bond B ....5 percent coupon due in five years

Bond C ....7 percent coupon due in ten years.

Currently the structure of yields is positive so that each bond sells for its par value. However, you expect that inflation will increase and cause interest rates to rise so that the structure of yields becomes inverted (i.e., a negatively sloped yield curve). You anticipate that interest rates will be 10, 9, and 8 percent for three-, five-, and ten-year bonds, respectively.

a) Given the current $1,000 price of each bond, what is each bond’s duration?

b) Given each bond’s duration, what is the forecasted change in the value of the bond?

c) If interest rates do change as you expected, what is the new price of each bond?

d) What is the forecasting error based on duration and the actual change in each bond’s price?

Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a...