QUESTION TWO

a). Discuss the four components of return on a bond investment over a given holding period. (8 marks)

b). Consider a bond selling at its par value of US $l 000, with a six year to maturity and a 7% annual coupon rate.

Required:

i) Calculate the bond's duration. (4 marks)

ii) What is the modified duration of the bond? (3 marks)

iii) If the yield to maturity on the bond increased to 8%, what happens to the bonds duration? Why does this change occur? (4 marks)

iv) Why must the duration of a coupon bearing bond always be less than the time to its maturity date? (3 marks)

c). Identify and briefly explain the three conditions that must be satisfied to immunize a portfolio. (3 marks)