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Problems On Duration

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muskaan.k1
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FAC633 Duration Monsoon 2023

Ahmedabad University

AY 2023-24| Monsoon Semester

FAC633: Security Analysis and Portfolio Management

Practice Problems on Duration, Convexity and Hedging

1. Consider a 2-year, 6% coupon bond that pays coupons on a semi-annual basis.


Calculate the following, assuming that the yield curve is flat at 7% per annum.
a. Macaulay’s duration
b. Modified Duration

2. You own a 10% treasury bond with $100 face value that has a modified duration of
9.5. The clean price is 115.25. You have just received a coupon payment 28 days ago.
Coupons are received on a semi-annual basis.
a. If there are 183 days in this coupon period, what is the accrued interest?
b. Is the yield great or lesser than the coupon rate? How do we infer?
c. What will be the approximate change in price if the yield were to suddenly fall
by 7 basis points.

3. Consider a 15-year bond that pays annual coupons of 8%, has a yield to maturity of
10%, and has a Macaulay’s Duration of 8.741261 years. If the market yield changes by
25 basis points, how much percentage change will there be in the bond's price based
on duration.

4. Consider a bond that has a 30-year maturity, an 8% coupon rate, and sells at an initial
yield to maturity of 8%. Because the coupon rate equals the yield to maturity, the
bond sells at par value: P = $1,000.00. Also, you are told that the modified duration
(D* ) of the bond, at its initial yield, is 11.26 years, and that the bond’s convexity is
212.4. Suppose that the bond’s yield increases from 8% to 10%. Estimate the dollar
change in bond price by applying the duration rule. Estimate the change in bond
process by applying the (1) duration and (2) duration-with-convexity rules. What
would be the actual revised bond price pursuant to change in YTM as stated above?

5. An investor holds 100,000 units of a bond whose features are summarized in the
following table. He wishes to be hedged against a rise in the interest rates.

Maturity Coupon Rate YTM Duration Price

18 years 9.5% 8% 9.5055 $114.181

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FAC633 Duration Monsoon 2023

Characteristics of the hedging instrument, which is a bond here, are as follows.


Maturity Coupon Rate YTM Duration Price

20 years 10% 8% 9.8703 $119.792

Coupon frequency and compounding frequency are assumed to be semi-annual. What


is the quantity of the hedging instrument the investor has to sell?
a. Should the yield curve increase instantaneously by 0.1%, what happens to the
bond portfolio if it is hedged? What happens to the bond portfolio if it is not
hedged?
b. Should the yield curve increase instantaneously by 2%, what happens to the
bond portfolio if it is hedged? What happens to the bond portfolio if it is not
hedged?

Hint: Assume a flat yield curve at 8% level.

6. The 6-month and 1-year zero rates today are 6.1% and 6.17% respectively. Six month
from today, the 1-year and 1.5-year rates are projected to be 6.3% and 6.6%
respectively.
a. Derive the price of 2-year bond that pays 5% coupon on semi-annual basis.
b. Derive Macaulay’s Duration of the 2-year bond.
c. Derive the Macaulay’s Duration of a portfolio wherein 70% of available funds
is invested in the 2-year bond and 30% is invested in 18-month zero bond.

Note: Yield curve is not flat. Derive necessary points of the spot yield curve before you
start answering sub-question (a). Assume semi-annual compounding.

7. Portfolio P constitutes assets A and B. Asset B is 5% annual coupon-paying bond with


a tenor of 3 years, while asset A is a 4Y zero bond. The market interest rate is 7%.
Assume annual compounding and a par value of Rs. 100 for this exercise. Should
portfolio P be immunized so as to meet liability payments of (a) Rs 2,00,000 three
years from now and (b) Rs. 2,50,000 four years from now, then
a. Derive the prices of assets A and B.
b. Derive the quantity of assets A and B that form part of the portfolio P. In other
words, derive the number of bonds of assets A and B that make up portfolio P.

8. You have a single liability of Rs. 250,000 payable 7 years from now. The yield curve is
flat at 6%. You wish to immunize this liability by buying two zero coupon bonds with
residual maturities of 5 and 10 years. Find the number of each zero bonds you need

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FAC633 Duration Monsoon 2023

to buy so as to ensure that your portfolio is immunized. Assume annual compounding


and bond par value of Rs. 100 for this exercise.

9. You have a single liability of Rs. 550,000 payable 10 years from now. The yield curve is
flat at 5%. You wish to immunize this liability by buying two zero coupon bonds with
residual maturities of 7 and 12 years. Find the number of each zero bonds you need
to buy so as to ensure that your portfolio is immunized. Assume annual compounding
and bond par value of Rs. 100 for this exercise.

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