Consider a 7-year 12% coupon bond, with a par value of $100. The yield curve is flat at 9.25% pa. Coupons are paid annually.

(a) Calculate both the Macaulay and the Modified duration. Use one of the duration measures to make an approximation of the percentage capital gain or loss if the yield increases by 25 basis points.

(b) Explain in words how we can make a more precise approximation. (c) Assuming yields do not change, what will be the duration of the bond one year later?