Problem
You are hired as a consultant for an investment firm. Your first job is to analyze a recent bond issued by a bank The bond is a 40 year bond that pays annual payments, with a face value of 350.000 and the yield is 12%. The bond currently pays a coupon rate of 7%. The investment firm wants you to answer the following questions about the bond issuance:
I. What is the price of the bond, according to the current situation?
II. If the Central Bank would increase interest rates 150 bps, what would the price be then?
III. How about if the Central Bank would decrease interest rates 150 bps?
IV. With the information you have from your calculations, what is the duration of the bond?
V. Now that you have calculated the duration. They want to know how the bond would react if interest rates would increase (and decrease) by only 50bps. In your answer, state if the price in increasing or decreasing.
VI. What could happen to the price of the bond, and the yield, if the news broke that the bank have been lying about their good balance sheet and are unlikely to be able to pay off their debts?