A bond that pays 5% interest semiannually has a 6% required rate of return and a price of $1045

Finance Jan 22, 2021

A bond that pays 5% interest semiannually has a 6% required rate of return and a price of $1045. Annual interest rates are now projected to increase by 80 basis points. The bond has a maturity 7 years and its duration is 5 years. What is the predicted new bond price after the interest rate change?

Expert Solution

Macaulay Duration = 5 years

Modified Duration = 5/(1 + (0.06/2))

Modified Duration = 4.854 years

Change in Price = -Modified Duration (change in yield)

Change in Price = -4.854(0.008) = -3.88%

New Price = (1 - 0.0388)(1,045)

New Price = $1,004.42

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