Question

a. Use a spreadsheet to calculate the duration of the two bonds in Spreadsheet 11.1 if the interest rate increases to 12%. Why does the duration of the coupon bond fall while that of the zero remains unchanged?

(Hint: Examine what happens to the weights computed in column E.)

b. Use the same spreadsheet to calculate the duration of the coupon bond if the coupon were 12% instead of 8%. Explain why the duration is lower. (Again, start by looking at column E.)

Short answer

Answer

a. 2.7714 and 3.0000

b. 2.6900

Step-by-step solution

Step by Step Solution Step 1: Given information

Coupon = 8%

Interest rate = 12%

Maturity = 7 years

Calculation of duration of coupon bond and zero bond ‘a’

Explanation on the fall of the duration bond

With the higher discount rate, the weight of the coupon bonds fall and those of earlier payments rise. Hence the duration falls.

Calculation of duration of coupon bond and zero bond ‘b’

Since, on the increase of the coupon, the weights of the earlier payments become higher, hence the duration falls.