Econ 435
Financial Economics
Fall 2001
Practice Problems
Midterm I
A useful equation you will be provided on the exam
% change in a bond’s price for a given dy
=
-MD*(dy) + VEX*( dy
2
) for small changes
in y.
Your bond portfolio consists of $1 million in bond A and $3 million in bond B. Bond
A has a Modified Duration (MD) of 8 and Convexity (VEX) of 60. Bond B has a
Modified Duration (MD) of 10 and Convexity (VEX) of 80. Use this information to
answer 1-4.
1) What is the Modified Duration of your portfolio?
2) What is the Convexity of your portfolio?
3)
If the yield to maturity on your portfolio increases by 10 basis points what will
happen to the value of your portfolio?
4)
There are 2 government bonds. Government bond X has a Modified Duration
(MD) of 5 and a Convexity of 40. Government bond Y has a Modified Duration
(MD) of 6 and a Convexity of 50. If you were to short these 2 government bonds,
what combination of government bonds would best hedge your bond portfolio
against interest rate changes?
Given the following zero-coupon yield curve, answer questions 5-7.
Years To Maturity
Zero-Coupon Yield To Maturity
1
4%
2
4.5%
3
5%
5
5.5%
10
6%
15
7%
20
8%
25
9%
30
10%
5) What is the implied forward yield on a 1-year bond 2 years from now?

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