Question

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.

Short answer

Duration = 7.1 years

Total Price change = 17.46%

Step-by-step solution

Given information

The effective duration = modified duration (in an option free bond)

Formula = ∆P/P = −D x ∆y

Calculation of duration of the bond in Table 11.9

Duration = (100.71 – 99.29) / (2 x 100 x 0.001)

= 7.1

Calculation of total percentage price change in Table 11.10

This can be calculated using the formula, change in yield multiplied by the negative value of modified duration multiplied by 100%

= -7.90 x -0.02 x 100

= 15.80%

Convexity adjustment = 1.66% (given)

Total price change = 15.80% + 1.66% = 17.46%