Assume that you own a $ 1 million par value corporate bond that pays 7 percent in coupon interest (3.5 percent semiannually), has four years remaining to maturity, and is immediately callable at par. Its current market yield is 7 percent and it is priced at par. If rates on comparable securities fall by more than 40 basis points (0.2 percent semiannually), the bond will be called.

a. Calculate the bond’s price if the market rate increases by 50 basis points (0.25 percent semiannually) using the present value formula from Chapter 6.

b. Calculate the bond’s effective duration assuming a 50 basis point increase or decrease in market rates.