In: Finance
Consider a bond with a coupon of 6.4 percent, six years to maturity, and a current price of $1,067.10. Suppose the yield on the bond suddenly increases by 2 percent.
a. Use duration to estimate the new price of
the bond.
b. Calculate the new bond price using the usual
bond pricing formula. (Do not round intermediate
calculations. Round your answer to 2 decimal places.)
K = N |
Bond Price =∑ [( Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N |
k=1 |
K =6 |
1067.1 =∑ [(6.4*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^6 |
k=1 |
YTM% = 5.07 |
a
Period | Cash Flow | Discounting factor | PV Cash Flow | Duration Calc |
0 | ($1,067.10) | =(1+YTM/number of coupon payments in the year)^period | =cashflow/discounting factor | =PV cashflow*period |
1 | 64.00 | 1.05 | 60.91 | 60.91 |
2 | 64.00 | 1.10 | 57.97 | 115.95 |
3 | 64.00 | 1.16 | 55.18 | 165.53 |
4 | 64.00 | 1.22 | 52.51 | 210.05 |
5 | 64.00 | 1.28 | 49.98 | 249.89 |
6 | 1,064.00 | 1.35 | 790.80 | 4,744.83 |
Total | 5,547.16 |
Macaulay duration =(∑ Duration calc)/(bond price*number of coupon per year) |
=5547.16/(1067.1*1) |
=5.198347 |
Modified duration = Macaulay duration/(1+YTM) |
=5.2/(1+0.0507) |
=4.947508 |
Using only modified duration |
Mod.duration prediction = -Mod. Duration*Yield_Change*Bond_Price |
=-4.95*0.02*1067.1 |
=-105.59 |
%age change in bond price=Mod.duration prediction/bond price |
=-105.59/1067.1 |
=-9.9% |
New bond price = bond price+Modified duration prediction |
=1067.1-105.59 |
=961.51 |
b
Actual bond price change |
K = N |
Bond Price =∑ [( Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N |
k=1 |
K =6 |
Bond Price =∑ [(6.4*1000/100)/(1 + 7.07/100)^k] + 1000/(1 + 7.07/100)^6 |
k=1 |
Bond Price = 968.13 |
b