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, 7% coupon, 10-year maturity, option-free corporate bond priced at par. The bond has the following features:

Change in Yields Up 10 Basis Points Down 10 Basis Points Price 99.29 100.71 Convexity measure 35.00 Convexity adjustment 0.0035

a. Calculate the modified duration of the bond.

b. Meer is also considering the purchase of a newly issued, 7.25% coupon, 12-year maturity option-free corporate bond. She wants to evaluate this second bond’s price sensitivity to an instantaneous, downward parallel shift in the yield curve of 200 basis points. Based on the following data, what will be its price change in this yield-curve scenario?

c. Meer asks her assistant to analyze several callable bonds, given the expected downward parallel shift in the yield curve. Meer’s assistant argues that if interest rates fall enough, convexity for a callable bond will become negative. Is the assistant’s argument correct?

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Original issue price Modified duration (at original price) Convexity measure Convexity adjustment (yield change of 200 basis points) Par value, to yield 7.25% 7.90 41.55 1.66