It is May 15, 2000 and an investor is planning to invest $100 million in one of the two portfolios below. The investor's main concern is the change in interest rates that might affect the short-term value of the portfolio. Compute the change in price of the security stemming from duration and convexity. Which portfolio is less sensitive to changes in interest rates? The portfolios are the following:

Portfolio A

- 30% invested in 5-year coupon bonds paying 2.25% quarterly

- 25% invested in 4 1/4-year coupon bonds paying 4.25% semiannually

- 20% invested in 90-day zero coupon bonds

- 15% invested in 2 1/2-year floating rate bonds with zero spread paid quarterly

- 10% invested in 6-year zero coupon bonds 

Portfolio B

- 40% invested in 7-year coupon bonds paying 0.5% semiannually

- 30% invested in 3 1/4-year floating rate bonds with 30 basis point spread paid semiannually

- 20% invested in 4-year coupon bonds paying 2.0% semiannually

- 10% invested in 90-day zero coupon bonds

Assume that semiannually compounded 6-month interest rate 3 months ago was 4.30%?

 

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Maturity 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 Yield 4.53% 4.69% 4.82% 4.91% 4.99% 5.04% 5.07% 5.08% 5.09% 5.08% Maturity 2.75 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00 Yield 5.06% 5.03% 5.00% 4.96% 4.92% 4.87% 4.82% 4.77% 4.71% 4.65% Maturity 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 Yield 4.59% 4.51% 4.44% 4.35% 4.25% 4.14% 4.01% 3.87% 3.70% 3.51% Maturity 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 Yield 4.53% 4.69% 4.82% 4.91% 4.99% 5.04% 5.07% 5.08% 5.09% 5.08% Maturity 2.75 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00 Yield 5.06% 5.03% 5.00% 4.96% 4.92% 4.87% 4.82% 4.77% 4.71% 4.65% Maturity 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 Yield 4.59% 4.51% 4.44% 4.35% 4.25% 4.14% 4.01% 3.87% 3.70% 3.51%

Answer rating: 100% (QA)

To compute the change in price of the security stemming from duration and convexity we need to calculate the duration and convexity for each bond in t... View the full answer