HADM 4280/6280
Homework Assignment #2 (individual)
Questions from Fabozzi, Chapter 4 (9th Edition)
4. Answer the below questions for bonds A and B (assume they pay interest semiannually).
Bond A
8%
8%
2
$100.00
$100.00
Coupon
Yield to maturity
Maturity (years)
Par
Price
Bond B
9%
8%
5
$100.00
$104.055
(a) Calculate the actual price of the bonds for a 100-basis-point increase in interest rates.
(b) Using duration, estimate the price of the bonds for a 100-basis-point increase in interest rates.
Hint: You need to compute duration using periodic (semiannual) payments. To obtain annual Macaulay
duration Dmac divide your answer by 2. To estimate the new bond price, use the price elasticity formula
P
 ( −D )(y )
P
,
mod
Dmod =
where
Dmac
(1 + y / 2 ) .
(e) (optional challenge, not graded) Without working through calculations, indicate whether the duration
of the two bonds would be higher or lower if the yield to maturity is 10% rather than 8%.
6. State why you would agree or disagree with the following statement: When interest rates are low, there
will be little difference between the Macaulay duration and modified duration measures.
10. Consider the following two Treasury securities:
Bond
A
B
Price
$100
$80
Modified duration (years)
6
7
Which bond will have the greater dollar price change after a 25-basis-point change in interest rates?
11. What are the limitations of using duration as a measure of a bond’s price sensitivity to interest-rate
changes?