a.

TP A

Time CF PV(CF) Weight t x weight

1 60 54.55 0.10 0.10
2 60 49.59 0.09 0.19
3 560 420.74 0.80 2.40
524.87 1.00 2.70

Macaulay Duration = 2.70 years

Modified Duration = 2.45 years

When YTM decreases 1% thus:

Price of bond A will increase 2.45 % so: P’ A= 524.87*(1+2.45%)= 537.73

TP B

Time CF PV(CF) Weight t x weight

1 50 45.45 0.09 0.09
2 50 41.32 0.08 0.17
3 50 37.57 0.08 0.23
4 550 375.66 0.75 3.01
500.00 1.00 3.49

Macaulay Duration = 3.49 years

Modified Duration = 3.17 years

When YTM decreases 1 %, thus:

Price of bond B will increase 3.17%:
P’B = 500*(1+3.17%)= 515.85
b.
Duration of loan:

Time CF PV(CF) Weight t x weight

1 500 446.43 0.29 0.29
2 500 398.60 0.26 0.52
3 500 355.89 0.23 0.70
4 500 317.76 0.21 0.84
1518.67 1.00 2.36

Macaulay Duration of loan = 2.36 years

To immunize interest rate risk, we need duration of assets equal to duration of loan
Let w is the invested weight of bond A, so (1-w) is the invested weight of bond B

w*2.7 + (1-w)*3.49 = 2.36

=> w = 1.43
=> 1- w = -0.43
c. Calculate convexity:

∆y = 1%
The new price of bond A based on the YTM increase 1% to 11%

Time CF PV(CF)
1 60 54.05
2 60 48.70
3 560 409.47
512.22
∆P/P = -2.41%

∆P/P = -D* x ∆y + 1/2 x convexity x (∆y)^2

=> convexity = 8.46