Assignment Instructions: Please answer each of the questions below in the blank spaces provided. Illegible answers will receive no credit.

Scenario:

Assignment Instructions: Please answer each of the questions below in the blank spaces provided. Illegible answers will receive no credit. Scenario: A portfolio manager wants to estimate the interest rate risk of a bond using duration. The current price of the bond is 106. A valuation model employed by the manager found that if interest rates decline by 25 basis points, the price will increase to 108.5 and if interest rates increase by the same number of basis points, the price will decline to 104. Questions: a. What is the duration of this bond? (Up to 3 points) ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ b. What is the convexity of this bond? (Up to 3 points) ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ c. Using the duration and convexity measures calculated above, estimate by how much the value of this bond would change if interest rates increase by 50 basis points. (Up to 5 points) Estimated change using duration = _________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Convexity adjustment = __________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Total estimated percentage price change = ___________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ d. Using the duration and convexity measures calculated above, estimate by how much the value of this bond would change if interest rates decrease by 50 basis points. Estimated change using duration = _________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Convexity adjustment = __________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Total estimated percentage price change = ___________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ e. Assume the bond portfolio manager purchased portfolio manager purchased $10 million in market value of the bond. Use the estimates above to determine the change in this portfolio value if interest rates increase by 50 basis points. (Up to 2 points). ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ f. Assume the bond portfolio manager purchased portfolio manager purchased $10 million in market value of the bond. Use the estimates above to determine the change in this portfolio value if interest rates decrease by 50 basis points. (Up to 2 points). ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________