A hedge fund specializes in investments in emerging market sovereign debt. The fund manager believes that the implied default probabilities are too high, which means that bonds are viewed as "cheap" and the credit spreads are too high. The hedge fund plans to take a position on one of these available bonds. Bond A B C Time-to- Maturity 10 years 20 years 30 years Coupon Rate 10% 10% 10% Price 58.075279 51.304203 50.210636 Yield-to- Maturity 20% 20% 20% The coupon payments are annual. The yields-to-maturity are effective annual rates. The prices are per 100 of par value. A. Compute the approximate modified duration of each of the three bonds using a 1 bp change in the yield-to-maturity and keeping precision to six decimals (because approximate duration statistics are very sensitive to rounding). B. Which of the three bonds is expected to have the highest percentage price increase if the yield-to-maturity on each decrease by the same amount - for instance, by 10 bps from 20% to 19.90%?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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8. A hedge fund specializes in investments in emerging market sovereign debt. The fund
manager believes that the implied default probabilities are too high, which means that
bonds are viewed as "cheap" and the credit spreads are too high. The hedge fund plans
to take a position on one of these available bonds.
Bond
A
B
C
Time-to-
Maturity
10 years
20 years
30 years
Coupon Rate
10%
10%
10%
Price
58.075279
51.304203
50.210636
Yield-to-
Maturity
20%
20%
20%
The coupon payments are annual. The yields-to-maturity are effective annual rates. The
prices are per 100 of par value.
A. Compute the approximate modified duration of each of the three bonds using a 1 bp
change in the yield-to-maturity and keeping precision to six decimals (because
approximate duration statistics are very sensitive to rounding).
B. Which of the three bonds is expected to have the highest percentage price increase
if the yield-to-maturity on each decrease by the same amount - for instance, by 10
bps from 20% to 19.90%?
Transcribed Image Text:8. A hedge fund specializes in investments in emerging market sovereign debt. The fund manager believes that the implied default probabilities are too high, which means that bonds are viewed as "cheap" and the credit spreads are too high. The hedge fund plans to take a position on one of these available bonds. Bond A B C Time-to- Maturity 10 years 20 years 30 years Coupon Rate 10% 10% 10% Price 58.075279 51.304203 50.210636 Yield-to- Maturity 20% 20% 20% The coupon payments are annual. The yields-to-maturity are effective annual rates. The prices are per 100 of par value. A. Compute the approximate modified duration of each of the three bonds using a 1 bp change in the yield-to-maturity and keeping precision to six decimals (because approximate duration statistics are very sensitive to rounding). B. Which of the three bonds is expected to have the highest percentage price increase if the yield-to-maturity on each decrease by the same amount - for instance, by 10 bps from 20% to 19.90%?
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