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A zero coupon bond matures in 5 years with a par value of $1000 and is currently selling at YTM of 8%.
a. What would be the approximate price of this bond if required rate of return drops to 6% using duration and convexity formula? What is the actual price of the bond when YTM is 6%? Why is there a difference between the two prices?
b. Why is the actual percentage change in price different when required rate of return increases by 2% as opposed to when required rate of return decreases by 2%? Explain this question by calculating actual percentage change in price of the bond at both 6% and 10% required rate of return.
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