Question: Suppose that you are an investor willing to buy a bond. This bond is a 5-year bond, with 6% coupon rate and a face value

Suppose that you are an investor willing to buy a bond. This bond is a 5-year bond, with 6% coupon rate and a face value of 1,000 pounds. Today, the bond is at par.

i. What is the price of this bond?

ii. What is the Macaulay duration of this bond?

iii. If you sell the bond 3 years after, what is your holding period return (assume that the bond is still at par)?

b) Assume that you hold a portfolio of 2 bonds. Bond A has a market value (price) of £1000 and bond B of £2000. The modified duration of bond A is 3.5 and of bond B 1.4.

i. What is the modified duration of your bond portfolio?

ii. What is the estimated price change (using duration) of your bond portfolio, if yields increase by 1%?

iii. How we can improve the approximation of the previous question, especially for large changes in the yields?

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