1) Your company owns the following bonds: Bond Market Value Duration A $13 million 2 B $18 million 4 ? $20 million 3 If

Question

1) Your company owns the following bonds: Bond Market Value Duration A $13 million 2 B $18 million 4 ? $20 million 3 If general interest rates decrease from 8.5% to 8%, what is the approximate change in the $ value of the portfolio? You must show your calculation, otherwise, your mark will be deducted. 2)An investor has the following two options: a) To buy a two-year $1,000 zero-coupon bond at a market price of $860, or. b) To buy a two-year $1,000 bond with an annual interest of 3% at a market price of $900. Assuming annual coupon payments, which option do you think the investor should choose? Explain why. You must show your calculation, otherwise, your mark will be deducted.

Help In Homework · Accepted Answer

1) Answer : Duration of Portfolio = Sum of [Weights * Duration] = [2 * (13 / 13+18+20)] + [4 * (18 / 13+18+20)] + [3 * (20 / 13+18+20)] = 0.51 + 1.41 + 1.18 = 3.09803921566 or 3.09 Change in Value = - Duration * [Change in Interest Rate / (1 + Intrest Rate)] * Total Market Value of Bond A,B &C = -3.09 * [(0.085 - 0.085) / (1 + 0.08)] * 51 million = -3.09 * [0.005 / 1.08] * 51 million = 729,583 2) BOND WITH PV =900 , COUPON =3% IS BETTER a) YTM = (FV / PV)1/N - 1 FV = 1000 PV = 860 N = 2 YTM = (1000 / 860)1/2 - 1 =1.07832 - 1 = 7.83% b) YTM = (C +(F -P / N)) / (F+P)/2 C =30 F =1000 P =900 N = 2 YTM = (30 + (1000 -900 / 2)) / (1000 + 900 / 2) = 80 / 950 = 8.42% option of coupon with Yield to maturity of 8.42% is better since zero coupon bond yields only 7.83%

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1) Your company owns the following bonds: Bond Market Value Duration A $13 million 2 B $18 million 4 ? $20 million 3 If general interest rates decrease from 8

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