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NEW QUESTION: 1
A bond pays semi-annual coupons at an annual rate of 10%, and will mature in a year. What is its modified duration? Assume the yield curve is flat for the next 12 months at 5%.
A. 0.953
B. 1.500
C. 0.700
D. 1.000
Answer: A
Explanation:
Explanation
We can calculate the duration of the bond as follows:
PV of 1st coupon payment: $5/(1 + 5%/2) = $4.878
PV of final payment: $105/(1 + 5%) = $100
Weighted average of the two = (0.5*$4.878 + 1*$100)/($4.878 + $100) = 0.9767, ie this is the Macaulay duration.
Thus the modified duration is 0.9767/(1 + 5%/2) = 0.9529
(Note that Modified Duration = Macaulay Duration/(1 + y/n), where n is the compounding frequency) In addition to this calculation, in this particular question we can intuitively arrive at the correct answer by eliminating the incorrect choices. Since the bond matures in a year, its modified duration will be less than a year. Therefore Choice 'a' and Choice 'b' cannot be correct. Similarly, 0.700 appears too low as the coupons are not so heavily weighted towards earlier in the year. Therefore only Choice 'c' can be the correct answer.

NEW QUESTION: 2
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