US Treasury Strip

Yield 1-year strip = 4.10%

10-year strip = 5.20%

30-year strip = 5.50%

Table A) Assuming face values of $1,000,000, Maria creates a spreadsheet to calculate the following for each of the three strips:

• market price (assuming the $1,000,000 face value)
• Macauley duration
• modified duration
• effective duration (Assume that the market yield shifts up and down by 25 basis points from the bonds base yield. For the pricing calculation, add or subtract the basis point change to the base yield and then cut the rate in half.)
• price value of a basis point (PVBP) per $1 million principal using the modified duration (The PVBP is calculated as .0001* Dmod*Price of Bond. It is an estimate of how much the bond's price will change, given a 1 basis point change in rates.)

Each bonds current market yield (see above) will serve as the base yield for that bond (strip) in her analysis. She completes Table A.

Table A	1-year	10-year	30-year
Market Price
Macauley Duration
Modified Duration
Effective Duration (assuming a 25 basis point shift up and down from the base rate)
PVBP Using Modified Duration

Question A1) Should her calculations for the effective and modified durations be very close for these types of bonds? Why?

Question A2) What are the fundamental differences in how the effective and modified durations are calculated? You will likely want to look back at the class discussion/notes and use some graphics in your answer.