Part I:
Question 1. Calculate the duration of a $1000, 6% coupon bond with three years to maturity. Assume that all market interest rates are 7%.
Question 2. Considered the bond in the previous question. Calculate the expected price change if interest rates drop to 6.75% using the duration approximation. Calculate the actual price change using discounted cash flow.
Part II:
Question 1. You paid 980.30 for an 8% coupon bond with a face value of 1000 that matures in five years. You plan on holding the bond for 1 year. If you want to earn 9% rate of return on this investment, what price must you sell the bond for? Is this realistic?
Question 2. You own a $1000 par zero-coupon bond that has five years of remaining maturity. You plan on selling the bond in one year and believe that the required yield next year will have the following probability distribution:
Probility Required Yield %
0.1 6.60%
0.2 6.75
0.4 7.00
0.2 7.20
0.1 7.45
A. What is your expected price when you sell the bond?
B. What is the standard deviation of the bond price?