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You are an aggressive investor. The information for the bonds available on the market is as follows:
Zero-coupon bond with 20 years left to maturity
A 10%, 20-year annual bond has a Macaulay duration of 10.18 years.
Assume that the market interest rates are at 8 percent.
Required: a) Calculate these bonds value at the current market interest rates. State whether the price of the bonds is sold at a premium, at par, or at a discount.
b) Using present value method, calculate the price of these bonds in one year if the market interest rates drop to 6.5%. What are the price changes in percentage?
c) Using Modified duration, by what percentage will the bond prices change if market interest rates drop to 6.5%?
d) Explain the difference in answer in parts (b) and (c).
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