1. Consider a 2-year, risk-free bond with a coupon rate of 6% (annual coupons) and a face amount of $1,000.

a. What is price of this bond if the YTM is 5%? 6%? 7%?

b. If you buy the bond for $1,000 (YTM = 6%), hold it to maturity and you reinvest the coupon payment at 5%, what is the annual HPR on your investment?

c. If you buy the bond for $1,000 (YTM = 6%), then the yield increases to 7%, and you sell the bond immediately after the first coupon payment (in 1 year), what is your HPR?

d. If the yield on the bond is 6% (P = $1,000),

i. What is the Macaulay duration?

ii. If the yield increases to 7% immediately, what does the duration approximation predict will be the percentage change in the bond price?

iii. If the yield increases to 7% immediately, what is the actual percentage change in the bond price?