Question 2 (17 marks)

a. Peter buys a 3% annual coupon bond with five years to maturity. The bond has a yield-to-maturity of 8%. The par value is $1,000.

i. Calculate the duration and modified duration of the bond. (5 marks)

ii. If the yield decreases to 7.5%, what is the new bond price using the duration concept? (3 marks)

b. At the end of next 2 years, you need to pay $100,000 and $150,000 respectively.

i. If the market interest rate is 6% per annum., what will be the duration of your payment obligation? (4 marks)

ii. Suppose you plan to fully fund the obligation using both 6-month zero coupon bonds and perpetuities. Determine how much of each of these bonds (in market value) you will hold in the portfolio. (5 marks)