QUESTION FIVE

a). How would you expect the spreads in bond yields to respond to the following macroeconomic events?

i. Recession

ii. High Inflation

iii. Tax cuts

iv. Stock market decline

v. Improved trade balance

Explain the reasoning behind each of your answers (10 marks)

b). Bond A and B both have Ksh. 10,000 face value, 8% yields to maturity, and ten-years term to maturity. However, bond A has a 10% coupon rate, whereas bond B sells at par. Both make annual interest payments. If the yields on both bonds decline to 6%, calculate the percentage price changes of the two bonds. (10 marks)

c). Liz owns a portfolio of four bonds with the following durations and proportions:

Bond Duration(Years) Proportions

A 4.5 0.20

B 3.0 0.25

C 3.5 0.25

D 2.8 0.30

What is the duration of Lizs bond portfolio? (5 marks)