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Homework answers / question archive / As an aggressive investor, your investment objective is to maximize capital gains
As an aggressive investor, your investment objective is to maximize capital gains. You are considering the purchase of a bond that would meet your objective. The information for the bonds available on the market is as follows:
? Bond A with duration of 2.45 years with yield to maturity of 6.5%
? Bond B with duration of 9.30 years with yield to maturity of 10%
? Bond C with duration of 8.75 years with yield to maturity of 5.75%
If the bonds are alike in all other respects, determine the bond you should purchase if you feel the market interest rates are going to decline by 0.25% in the near future. Explain and provide a numerical evidence to support your answer. (Explain your answer please)
ANSWER =
we can say that we should choose bond with the highest duration when yields fall. Hence choose Bond B
% Change in Price=-Modified Duration*Change in Yields=-Duration/(1+yield)*Change in Yields
Bond A=-2.45/1.065*(-0.25%)=0.5751%
Bond B=-9.30/1.1*(-0.25%)=2.1136%
Bond C=-8.75/1.0575*(-0.25%)=2.0686%
As price of Bond B rises the most, choose Bond B.
