Bond Analysis

Question 1

if market interest rates increase above the bond’s YTM, the bond price will ___

Answer 1

decrease

Question 2

if market interest rate decrease below a bond’s YTM, the bond price will ____

Answer 2

increase

Question 3

average time for a bondholder to receive the interest and principal payments from a bond in present value dollars

Answer 3

duration

Question 4

measures a bond’s sensitivity to market interest rate changes

Answer 4

duration

Question 5

the greater the bond’s duration, the ____ the bond’s price volatility

Answer 5

greater

Question 6

Calculate the duration of the following bond:

$1000 par value
3 year bond
7% coupon
trading at Par

Answer 6

Use Cash Flow Keys

CF 0 = 0
CF 1 = $70
CF 2 = $70 x 2
CF 3 = ($70 + $1,000) x 3

I = 7%

NPV = $2,808

divide NPV by current price

$2,808 / $1,000 = 2.808 years

Question 7

what is the estimated change in the price of the following bond using duration?

original bond

$1,000 par value
trading at par
7% coupon
3 year bond

YTM of the bond changes to 8%

Answer 7

calculate duration first

CF 0 = $0
CF 1 = $70
CF 2 = $140
CF 3 = ($70 + 1000) x 3 = $3,210

I = 7%

NPV = $2,808 
Duration = $2,808 / $1,000 = 2.808 years

percentage change = -2.808 [(.08-.07)/(1+.08)] = - .026 or -2.6%

dollar change = $1,000 x .026 = $26

new price = (1 - .026) X 1,000 = $974