Question 1 (30 marks)

Imagine a $100 face value bond with 4 years to maturity that:

• Pays annual coupons at a rate of 8% per annum; and,
• Has a yield to maturity of 8% per annum.

Required

1. Will the bond be trading at a premium, at par, or at a discount to face value? [5 marks]
2. The Macaulays duration is computed as 3.5771, what is the bonds modified duration. Interpret the economic meaning of this modified duration [10 marks]
3. Now, imagine that the bonds yield to maturity decreases to 7.5% per annum. Use your answer in question B to estimate the change in the bonds price stemming from the change in its yield. [5 marks]
4. Using the bond valuation formula, calculate the exact change in price following the decrease in the bonds yield to maturity described in it. [5 marks]
5. Are your answers the same? Why/Why not? [5 marks]