Solution-What risks would the investor of bond be exposed to

What risks would the investor of bond be exposed to

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Reference no: EM132777135

Imagine a government bond with the face value of $100 and 4 years to maturity that:

Pays annual coupons at a rate of 8% per annum; and,
Has a yield to maturity of 7% per annum.

Required

What risks would the investor of this bond be exposed to?
Would the bond be trading at a premium, at par, or at a discount to face value? Explain why.
The Macaulay's duration is computed as 3.5847 years, what is the bond's modified duration? Interpret the economic meaning of this modified duration.
Imagine that the bond's yield to maturity decreases to 6% per annum, estimate the dollar change in the bonds price stemming from the change in its yield using the duration method.
The convexity is computed as 8.6234 years. Assume that the bond's yield to maturity decreases to 6% per annum, estimate the dollar change in the bond's price stemming from the change in its yield using the convexity method.
Using the bond valuation formula, calculate the exact change in bond price following the decrease in the bond's yield to maturity to 6% per annum.
Are your answers in 4, 5 and 6 the same? Why/Why not?
Assume that this bond contract has a call provision at the end of year 2 at a price of $96.529 (right after the coupon payment for year 2). Assume that the yield at the end of year 2 is 9% p.a., would the bond issuer exercise the call provision to buy back the bond at $96.529? Explain why.

Reference no: EM132777135

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What risks would the investor of bond be exposed to

Reference no: EM132777135

Reference no: EM132777135

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