Question
***Please make this easy to follow. The par value is not stated.*** A straight bond with a coupon rate of 8 percent sells at a
***Please make this easy to follow. The par value is not stated.*** A straight bond with a coupon rate of 8 percent sells at a yield to maturity of 9 percent. The bond matures in 10 years.
Compute the bonds modified duration. (Your financial calculator will most efficiently help solve for this.) How can this value be used?
Compute the Macaulay duration of the bond and explain what it means.
Suppose the yield to maturity was originally 7 percent. Re-compute the Macaulay duration. What does this tell you about the relationship between duration and the yield to maturity?
Suppose in the original question, the yield to maturity suddenly rose by one quarter of a percent. Use duration to estimate the new price of the bond. How does your answer compare to the new bond price calculated from the bond pricing formula. Does it differ by that much? If the yield to maturity increased by 1 percent, what effect would this have on the predicted price of the bond compared to the actual new bond price?
Lifeco Insurance Company needs to have $100 million 5 years from today to satisfy life insurance claims. Lifeco purchases 8 percent coupon bonds selling at par with a maturity of 6.2 years. Assume immediately after the purchase, an interest rate shock causes bond yields to jump up to 10%.
Immediately after the price shock, suppose Lifeco Insurance Company can purchase bonds selling at par that offer a 10 percent coupon. What will the maturity of these bonds be? (Round to 2 decimal places)
Six months go by and Lifeco Insurance Company wants to re-balance its portfolio. Lifeco has available bonds it can purchase that have a coupon of 8 percent and yield 9.75 percent. What will the maturity of these new bonds be? (Round to 2 decimal places) Suggestion: This can most efficiently be solved using an Excel spreadsheet.
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