Frank Meyers, CFA, is a fixed-income portfolio manager for a large pension fund. A member of the Investment Committee, Fred Spice, is very interested in learning about the management of fixed-income portfolios. Spice has approached Meyers with several questions. Specifically, Spice would like to know how fixed-income managers position portfolios to capitalize on their expectations of future interest rates.

Meyers decides to illustrate fixed-income trading strategies to Spice using a fixed-rate bond and note. Both bonds have semiannual coupon periods. Unless otherwise stated, all interest rate (yield curve) changes are parallel. The characteristics of these securities are shown in the following table. He also considers a nine-year floating-rate bond (floater) that pays a floating rate semiannually and is currently yielding 5%.

Characteristics of Fixed-Rate Bond and Fixed-Rate Note
	Fixed-Rate Bond	Fixed-Rate Note
Price	107.18	100.00
Yield to maturity	5.00%	5.00%
Period to maturity	18	8
Modified duration	6.9848	3.5851

Spice asks Meyers (see previous problem) to quantify price changes from changes in interest rates. To illustrate, Meyers computes the value change for the fixed-rate note in the table. Specifically, he assumes an increase in the level of interest rate of 100 basis points. Using the information in the table, what is the predicted change in the price of the fixed-rate note?

What is the duration of the bond if coupons are paid annually? Explain why the duration changes in the direction it does.

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