Question 2 - Duration and Interest Rates (17 marks)

a) Calculate the PV, RV, WV and Macaulay duration of a 5-year, $1,000 face value, 14 percent coupon bond yielding 15 percent with coupons paid annually. (6 marks)

b) Why is interest rate risk important to a financial manager and how can a financial manager use the Macaulay duration to hedge against interest rate risk? (3 marks)

c) Next, use the Macaulay duration to calculate what happens to the price of the bond when the yield to maturity falls to 14 percent. (2 marks)

d) Why is the price of the bond you calculated using the Macaulay duration not equal to $1,000? (2 marks)

e) Finally, how do you explain the appearance of a humped-shaped (or bell-shaped) yield curve in the 1990s? (4 marks)