You purchased another bond with the following characteristics:
$1,000 par value 6.5% coupon, annual payments
25 years to maturity Callable in 7 years at $1,065.
You paid $1063.92 for the bond. Macaulay duration is 13.34 years
Assume market rates drop by 50 basis points.
a. What will be the new bond price?
b. Using modified duration, estimate the value of the bond following the decrease in interest rates.
c. The estimate (from part b), is fairly close to the actual (in part a). What explains the difference in the two values? Be specific.
d. Calculate the effective duration of this bond. Use shifts of 50 basis points.
e. Calculate the yield to call.
f. Of the three duration measures (Macaulay, modified, effective) which is the most appropriate measure for this bond? Why?