Chapter 10
What happens to a bond’s price when the coupon rate equals the market interest rate?
It sells at par value
Which bond has higher interest rate risk: a 3% coupon bond or an 8% coupon bond (same maturity)?
The 3% coupon bond
lower coupon = higher sensitivity
What type of bond allows the issuer to repurchase it before maturity, usually when interest rates fall?
A callable bond
What is the main limitation of immunization in bond portfolio management?
It requires rebalancing over time and may not perfectly eliminate risk.
What do we call the rate that makes the present value of a bond’s cash flows equal to its price?
Yield to Maturity, YTM
What is the main purpose of immunization in bond portfolio management?
To protect the portfolio against interest rate risk by matching asset and liability durations.
A 5-year bond has a 4% annual coupon and a $1,000 face value. If the market discount rate is 6%, calculate the approximate bond price.
915,75
A 3-year bond has a 6% annual coupon, face value = $1,000, and YTM = 5%.
Calculate the Macaulay Duration and modified duration
D= 2,91
D*= 2,77
Explain the difference between Yield to Maturity and Holding Period Return.
YTM is the discount rate equating bond price to PV of cash flows, assuming reinvestment at YTM and holding until maturity. HPR is the actual return over an investor’s horizon, depending on sale price, coupons, and reinvestment rate.
Why do investors prefer bonds with higher convexity, and what is the trade-off?
Higher convexity means bond prices increase more when yields fall and decrease less when yields rise, making them less risky. However, investors must pay more for bonds with higher convexity.