Chapter 11, Problem 6CP

Summary Introduction

(a)

To calculate:

The duration of the bond

Introduction:

A bond is a security that creates an obligation on the issuer to make specified payments to the holder for a given period of time. The face value of the bond is the amount the holder will receive on maturity along with the coupon rate which is also known as the interest rate of the bond. Yield to maturity is defined as the discount rate that makes the present payments from the bond equal to its price. In simple terms, it is the average rate of return a holder can expect from a bond. Current yield is a bond's annual income divided by the current price of the security. Duration is an approximate measure of a bond's price sensitivity to changes in interest rates.

Convexity is termed as a measure of the curvature in the relationship between bond prices and bond yields that demonstrates how the duration of a bond changes as the interest rate changes.