Following your graduation, you are employed by a bond trader who asks you to prepare an analysis
Question:
Following your graduation, you are employed by a bond trader who asks you to prepare an analysis of an Australian Treasury bond maturing in 4 years with a face value of $100,000, a coupon of 5% per annum payable yearly and a yield to maturity of 3% per annum. The interest coupon payment due this year has just been paid.
Your employer has also advised that he considers that the yield to maturity is expected to increase very soon to 4% per annum. On the assumption that the yield increase will occur later today, calculate the new bond price (correct to the nearer cent) by each of the following methods:
- The duration adjustment methods
- The duration-with-convexity adjustment method.
- The present value of future cash flows method.
Also, Which of the above 3 methods would you recommend as the most accurate? Referring to d. above, explain why method ii. gives a more accurate answer than method i.