QUESTION 2 :

A newly issued bond has a maturity of 10 years and pays a 7% coupon rate (with coupon payments coming once annually). The bond sells at par value.

Required:

1. Calculate the convexity and the duration of the bond.
2. Examine the actual price of the bond assuming that its yield to maturity immediately increases from 7% to 8% (with maturity still 10 years).
3. Determine what price would be predicted by the duration rule and duration-with-convexity rule than distinguish the percentage error of that each rule.
4. Explain the impact on both effective bond duration and convexity of adding a call feature to a proposed bond issue.