Question

Anderson bought a bond with a modified duration of 11.20. By approximately what percentage will the bond price change assuming interest rates increase by 90 basis points?

a. -11.20%

b. -10.08%

c. +10.08%

d. +11.20%

Answer 1

Solution:

As per the information given in the question

The Modified Duration of the bond = 11.20 years

The Interest rate and price of a bond are inversely related. This relationship is explained by the modified duration of the bond.

Inference for Modified Duration:

For every one percentage increase in the interest rate, price of the bond will decrease by the ( Modified Duration * percentage of increase in interest rate )

For every one percentage decrease in the interest rate, price of the bond will increase by the ( Modified Duration * percentage of decrease in interest rate )

As per the information given in the question the interest rates increase by 90 basis points = 0.90 %

Thus since the interest rate is increasing by 0.90 % , the price of the bond will decrease by

= 0.90 % * 11.20

= 10.08 %

Thus the price of the bond will decrease by 10.08 %

Thus the percentage by which the bond price will change assuming interest rates increase by 90 basis points = - 10.08 %

Thus the solution is Option b. - 10.08 %