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Consider a two-year 8% coupon bond with a face value of $1000. Suppose that the yield on the bond is 10% per annum with continuous

Consider a two-year 8% coupon bond with a face value of $1000. Suppose that the yield on the bond is 10% per annum with continuous compounding. Coupons are semi-annual.

You perform the following calculations:

Time (years)

Cash Flow ($)

Present Value of Cash Flow ($)

Weight

(PV of Cash Flow / Bond Price)

Time x Weight, years

Time2 x Weight, years2

0.5

40

38.05

38.05/960.15 = .040

0.5 (0.040)

(0.5)2 (0.040)

1.0

40

36.19

.038

1.0 (.038)

(1.0)2 (0.038)

1.5

40

34.43

.036

1.5 (.036)

(1.5)2 (0.036)

2.0

1040

851.48

.887

2 (.887)

(2.0)2 (0.887)

Total

960.15

1.88

3.68

Suppose the yield increases by 200 basis points (2%). Calculate the new value of the bond using both duration and convexity.

a.

973.98

b.

965.31

c.

924.66

d.

958.34

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