Chapter 3: Q.10I (page 360)
A pension plan is obligated to make disbursements of \(1 million, \)2 million, and $1 million at the end of the next three years, respectively. Find the duration of the plan’s obligations if the interest rate is 10% annually.
Answer
1.9524 years.
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Currently, the term structure is as follows: One-year bonds yield 7%, two-year bonds yield 8%, three-year bonds and greater maturity bonds all yield 9%. You are choosing between one-, two-, and three-year maturity bonds all paying annual coupons of 8%, once a year. Which bond should you buy if you strongly believe that at year-end the yield curve will be flat at 9%?
What is the option embedded in a callable bond? A puttable bond?
a. Footnote 2 in the chapter presents the formula for the convexity of a bond. Build a spreadsheet to calculate the convexity of the 8% coupon bond in Spreadsheet 11.1 at the initial yield to maturity of 10%.
b. What is the convexity of the zero-coupon bond?
The following bond swaps could have been made in recent years as investors attempted to increase the total return on their portfolio.
From the information presented below, identify possible reason(s) that investors may have made each swap.
a. Janet Meer is a fixed-income portfolio manager. Noting that the current shape of the yield curve is flat, she considers the purchase of a newly issued, option-free corporate bond priced at par; the bond is described in Table 11.9. Calculate the duration of the bond.
Meer is also considering the purchase of a second newly issued, option-free corporate bond, which is described in Table 11.10. She wants to evaluate this second bond’s price sensitivity to an instantaneous, downward parallel shift in the yield curve of 200 basis points. Estimate the total percentage price change for the bond if the yield curve experiences an instantaneous, downward parallel shift of 200 basis points.
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