Consider a coupon bond that pays an 8% coupon semiannually. It matures in 5 years. Suppose that the bond’s yield to maturity is 7.75%.
PLEASE TRY TO ANSWER MOST OF THEM IF YOU CAN, OR AS MUCH AS POSSIBLE.
1. Compute the Macaulay duration in years.
2. Compute the Modified duration in years.
3. Compute the Dollar duration in years.
4. What if the bond does not pay any coupons at all? What could have been the duration?
5. Compute the convexity measure of this coupon bond in years.
6. What will happen to the price of this bond in terms of percentage and dollars, if the market interest rate falls by a basis point? Your answer must be justified both in terms of duration and convexity.
7. Recompute the Modified duration and the convexity measures for this bond by using the approximate formula.
8. What is the fundamental weakness of these methods of computing the effect of a change in the market yield on the price of bonds? Or, what would you caution when you use these formula?