QUESTION ONE

Assume that there are two available bonds to buy. Bond A has a maturity of 4 years, a coupon rate of 8% a yield to maturity of 6%, a face value of 1000, and it pays annual coupons. Bond B is a zero-coupon bond with a maturity of 4 years, yield to maturity of 6% and face value of 1000.

1. Calculate the Macaulay duration for both bonds.
2. Based on duration, which bonds price has a higher sensitivity to changes in the interest rates?
3. Assume that yields to maturity increase by 2% for both bonds. Calculate their percentage price change as a result of the increase in the yields, using duration.
4. How accurate was the estimated price change using duration? Explain your answer.