Reference no: EM133120870
Say we have a fixed-rate 10-year bond with a face value of $1000, a coupon rate of 5.5%, and annual coupon payments. The bond is non-amortizing, that is, the entire principal is repaid when the bond matures in 10 years.
-Draw all the cash flows (including negative and positive, that is, both payments made and payments received for the bondholder) for the bond on a timeline (e.g. with a bar chart ... no need to use Excel, though that would make it look neater).
-What should an investor pay for this bond if she expects to get a yield to maturity of 5.5 percent?
-Suppose the investor instead expects a yield to maturity of 6 percent. Calculate what she should pay for the bond. Calculate what she should pay for a yield to maturity of 5 percent. What is the general direction of the relationship between price and yield?
-What is the bond's duration (to two-decimal places) when the yield is 5.5%? What about when the yield is 5%? What about when the yield is 6%. In what units is duration measured?
-Based on your calculation of duration when the bond's yield is 6 percent, by about what percent will the price of the bond change if the yield changes by 1%, using the approximation formula from the lecture? What is the actual percentage price change when the yield goes from 6% to 5%?
Recalculate the duration for a 10-year bond with a 7 percent coupon, assuming the bond yields 6%. Is the duration higher, lower, or the same than the bond with a 5.5% coupon and a yield to maturity of 6%? Why?