Quiz # 2 Name____________________________

Problems
1 .(10 points) Kwan Tran holds a $100,000 face value corporate bond denominated in Singapore
dollars. It has 8 years to maturity and pays a 6% annual coupon rate and it makes semi-annual
coupon payments of $3000. The current interest rate or yield to maturity for this type of bond
should be 8% (4% semi-annually). The current price of the bond is $88,347.70
a. He has determined that the duration for this bond is 6.353 years. Determine the
modified duration.
D mod = D/ (1+i/2) and since I = .08, D = 1/1.04 = 6.108 or 6.109 years depending upon
rounding

b. Based on duration, what is the new price of the bond be if annual interest rates rise to 9%?
-6.653(.01) = -.0653 and this is the change I the bond price from the one percent
increase in interest rates.
So (1-.0653)(88347.70) = 82,734.97
(It is based on the actual price of the bond, not face value)
c. Using modified duration, what is the price of the bond if annual interest rate rise to 9%?
(-6.109)(.01) = -.06109 and (1-.06109)(88,347.70) = either 82,950.54 or 82,951.43
depending on rounding in part b

D .Using the bond pricing formula, what is the new price of the bond 9% annual interest rates?
83,148.98,
remember to use 16 semi annual periods and i/y = 4, FV=100,000 and the coupon or
PMT = 3000
e. How far off in % (to two decimal places) is the bond price when you estimate the price using
modified duration?
About 0.24% difference when comparing the answers in parts c and d. This is a pretty small
error compared to what you often see using duration.

2. Let us assume that the yield curve for Mexico based on spot rates for zero-coupon bonds in
October of 2023 is as follows:
A. Fill out the chart for the unknown forward rates for years 2, 3, and 4. Use the
multiplicative approximation. (6 points)
 Time to maturity spot rate (%) forward rate (%)
1 4% 4%

2 6% 8.04%

3 6.5% 7.51%

4 7.0% 8.51%

Plug into the formula that is given. Do it for years 2, 3, and 4. You also have to subtract one from
your number and convert to %. For example for year 4,

f t=¿ ¿= ), f t=¿ ¿ = 1.0851 which then becomes a rate of 8.51%

3. Using the data ABOVE, what is your best guess for the interest rate for a one-year zero-coupon bond
in Mexico 3 years from now for years 2026 to 2027 (in year 4)?

Just look at the entry for year 4. This estimated forward is the forecasted one year interest rate at the
start of year 4

4. Using the data on the previous page, Mexico’s yield curve for 2023 is
a) downward sloping or inverted
b) flat, which is normal
c) upward sloping, signaling a bad recession coming
d) upward sloping, which is normal

5. Under which theory of the yield curve is it impossible to have an inverted yield curve?
a. expectations theory
b. liquidity preference theory
c. segmented markets theory
d. preferred habitat theory

6. Which of the following Treasury bonds would you expect to have the longest duration?
a) 10% coupon, 20-year bond
b) 6% coupon, 20-year bond
c) 8% coupon, 10- year bond
d) 4% coupon, 10- year bond

7. Which of the following would be the best example of spread duration?

a) difference in duration between the 30-year treasury bond and the 10-year treasury bond
b) difference in yield between a 10-year treasury bond and a high-grade 10-year corporate bond
c) difference in duration between a 10-year treasury bond and a high-grade 10-year corporate bond
d) the difference in duration between a 10% coupon, 10-year corporate bond and a 6% coupon. 5-year
Treasury bond
e) the amount of time I spent spread out on the floor studying for this quiz

8. (extra credit) The duration measure (without convexity adjustment) for a corporate bond
a) underestimates the price change as interest rates change
b) overestimates price changes when interest rates increase and underestimates price changes when
interest rates decrease
c) underestimates price changes when interest rates increase and overestimates price changes when
interest rates decrease
d) overestimates price changes no matter which direction interest rates change
For this one, you have to think about the graph showing the relationship between a bond’s price and
interest rates as estimated by both duration and the bond pricing formula.

Formulas:
modified duration = D mod = D/ (1+i/2), for semi-annual coupon bonds and i = annual yield to
maturity or current annual interest rate.

forward rates (f) and spot rates (s), f t=¿ ¿