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Answerawillbehigher thereare2waystothinkaboutthis 1

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Unformatted text preview: d, both bond prices will increase, as yield goes opposite to the price. b) Intuitively, which bond (a or b) has the higher price at this new yield? Answer: (a) will be higher. There are 2 ways to think about this: 1) Think Convexity: (a) has higher convexity, which means that there is more curvature to the relationship between price and yield (see graph in lecture). Hence at a lower yield, price will be higher. 2) Think Duration: As (a) has a longer modified duration (MD), it will be more sensitive to yield change. c) Calculate the estimate price of bond using duration and convexity. Answer: MD: (a) 4.007 (b) 2.777; Price change: (a) 3.03 (b) 2.09 Question 3: (From Problem Set 1, Question 2) Consider the following zero‐coupon bond prices: Years to Maturity Zero‐Coupon Bond Price 1 0.943396 2 0.881659 3 0.816298 a) Using the information from part (a), calculate the implied forward rate between year 1 and year 2. Answer: 7% b) Now let’s take a look at examples of arbitrage opportunities. Suppose that a bank is offering...
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This note was uploaded on 01/28/2013 for the course SEEM 5840 taught by Professor Doctorw during the Fall '12 term at CUHK.

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