Suppose you are trying to determine the interest rate sensitivity of two bonds. Bond 1 is a 12% coupon bond with a 7-year maturity and a $1000 principal. Bond 2 is a ‘zero-coupon’ bond that pays $1120 after 7 year. The current interest rate is 12%.
- Determine the duration of each bond.
- If the interest rate increases 100 basis points (100 basis points = 1%), what will be the capital loss on each bond?