Question

1 (a) Determine the approximate percentage change in
price for a bond whose coupon rate changes from 10% to 12% if the
duration is -6.76%.

(b) What would be the new price if the old price was
GHS5.78?

2. A 10-year, 7% coupon
bond with a face value of $1,000 is currently selling for $871.65.
Compute your rate of return if you sell the bond next year for
$880.10.

3. One-year interest rate over the next five years are
expected to be 15%, 16%, 17%, 18% and 19%.

Required:

i. Determine the interest rate on one to five-year bonds
today.

ii. investors have preference for holding short-term
bonds so their liquidity premium for holding one-to five-year bonds
are 0%, 0.25%, 0.50%, 0.75% and 1%. Determine the interest rate on
one to five-year bonds
today.

Answer #1

**Question
1**

**a) Determination of change in price**

**Step 1: Calculation of Modified
Duration**

**Modified Duration = Duration
/ (1+Yield To Maturity)**

= -6.76 / 1.1

**= -6.15**

*Since YTM is not provided in question, current interest rate is taken as YTM.

**Step 1: Calculation of percentage change in
price**

**Percentage change in price =
Modified Duration * percentage change in YTM**

= -6.15 * (12%-10%)

= -6.15 * 2

**= -12.30%**

**(b) Calculation of new price**

Old price = 5.78

**New price =** 5.78 +
5.78 * 12.30%

= **6.49**

***In** this case bond have negative duration. That
means the direction of change in interest rate and bond price is
same. When interest rate increases, price also increases and
vice-versa.

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