Question 2
a) You expect interest rates to increase over the next six months. You must make a choice
between the two sets of bonds below. For each set, select the bond that would be best for
your portfolio. Briefly discuss why you selected the bond.
Maturity Coupon YTM
Set1
Bond A
20
years
15%
15%
Bond B
20
12%
13%
years
Set 2
Bond C
20
12%
15%
years
Bond D
15
14%
15%
years
F20
(30 marks)
b) The table below displays the par values, annual yields to maturity, annual coupon rates,
maturities, and credit ratings of three corporate bonds:
Bond
Par ($)
Yield To
Coupon
Maturity
Credit
issuer
Maturity % rate %
ratings
A
1000
10%
8%
3 years
AA
B
1000
12%
13%
3 years
BBB
C
1000
14%
15%
3 years
BB
All the bonds are semi-annual bonds
b.1) Calculate the price of each bond.
(15 marks)
b.2) Calculate the Macaulay duration of each bond. Which bonds have the longest and
shortest durations?
(15 marks)
b.3) What is the approximate percentage change of Bond C's price when interest rates
decrease by 240 basis points?
(10 marks)
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