Problems

5.1. A 9-year bond has a yield of 10% and a duration of 7.194 years. If the market yield
changes by 50 basis points, what is the percentage change in the bond’s price?

5.2. Find the duration of a 6% coupon bond making annual coupon payments if it has 3
years until maturity and has a yield to maturity of 6%. What is the duration if the yield to
maturity is 10%?

5.3. Find the duration of the bond in Problem 7.2 if the coupons are paid semiannually.

5.4. An insurance company must make payments to a customer of $10 million in 1 year
and $4 million in 5 years. The yield curve is flat at 10%.

a) If it wants to fully fund and immunize its obligation to this customer with a single
issue of a zero-coupon bond, what maturity bond must it purchase?

b) What must be the face value and market value of that zero-coupon bond?

5.5. You will be paying $10,000 a year in tuition expenses at the end of the next 2 years.
Bonds currently yield 8%.

a) What is the present value and duration of your obligation?

b) What maturity zero-coupon bond would immunize your obligation?

c) Suppose you buy a zero-coupon bond with value and duration equal to your obligation.
Now suppose that rates immediately increase to 9%. What happens to your net position,
that is, to the difference between the value of the bond and that of your tuition obligation?
What if rates fall to 7%?

5.6. A newly issued bond has a maturity of 10 years and pays a 7% coupon rate (with
coupon payments coming once annually). The bond sells at par value.

a) What are the convexity and the duration of the bond?

b) Find the actual price of the bond assuming that its yield to maturity immediately
increases from 7% to 8% (with maturity still 10 years).

c) What price would be predicted by the duration rule? What is the percentage error of that
rule?

d) What price would be predicted by the duration-with-convexity rule? What is the

percentage error of that rule?