Respond to the question selected by your instructor giving real-world examples to support all your answers.
1. What does duration measure and how is the measure used by investors?
2. How would you assess interest rate risk when investing in bonds?
3. Discuss two macro variables that affect changes in interest rates. If you watch these variables, could you predict interest rate movements, even if only approximately?
4. You own a fixed-income asset with a duration of five years. If the level of interest rates, which is currently 8%, goes down by 10 basis points, how much do you expect the price of the asset to go up (in percentage terms)?
5. Rank the interest rate sensitivity of the following pairs of bonds.
- A .Bond A is an 8% coupon, 20-year maturity bond selling at par value.Bond B is an 8% coupon, 20-year maturity bond selling below par value.
- B .Bond A is a 20-year, noncallable coupon bond with a coupon rate of 8%, selling at p ar. Bond B is a 20-year, callable bond with a coupon rate of 9%, also selling at par.
6. You will be paying $10,000 a year in tuition expenses at the end of the next two years. Bonds currently yield 8%.
- a.What is the present value and duration of your obligation?
- b.What maturity zero-coupon bond would immunize your obligation?
- c.Suppose you buy a zero-coupon bond with value and duration equal to your obligation. Now suppose that rates immediately increase to 9%. What happens to your net position, that is, to the difference between the value of the bond and that of your tuition obligation? What if rates fall to 7%?