You are given three bonds for valuation and risk assessment. They all mature in five years, have a principal of £100 and coupons are paid annually. Further information is provided in the following table: Bond X Bond Y Bond Z Coupon rate 4% 8% 10% YTM 8% 8% 8%

(a) Which bond should be priced at a discount and which bond should be priced at a premium? Which bond, if any, should have its price being equal to its face value? 

(3 marks) (b) Calculate the bond price for these three bonds and justify your judgement above. 

 (c) Calculate both Macaulay duration and modified duration for these three bonds and deliberate the reasons for introducing modified duration.

 (d) Contrast the durations of the comparable pairs of these bonds, with regard to their differences in YTM and/or coupon rates.

 (e) What is meant by bond convexity? Suppose the convexity of Bond X is 50, estimate the change in Bond X’s price that would be associated with a 1% increase in spot rates. 

Answer rating: 100% (QA)

a Bond X should be priced at a discount because its coupon rate is less than its YTM Bond Z should be priced at a premium because its coupon rate is greater than its YTM Bond Y should be priced at its ... View the full answer