Firm X has $25 million of risk-free debt outstanding. This debt has an annual coupon rate of 6% and matures in 2 years. Coupons are paid once per year. The current term structure is flat at 10% per year, compounded annually.

1. What is the current market value of the firms debt? (2 points)

2. What is the duration of the firms debt? (4 points)

3. Suppose yields fall by 500 basis points (from 10% to 5%). Calculate the modified duration and use it to approximate the new market value of the firms debt. (4 points)

4. Suppose yields fall by 500 basis points (from 10% to 5%). Calculate the convexity and use it to approximate the new market value of the firms debt. (4 points)
5. You believe yields are going to fall in the near futur Should you increase or decrease the convexity of your bond portfolio? How does your answer change if you believe yields are going to rise instead? Explain why. Be BRIEF. (6 points)