Investments, 11th Edition (exclude Access Card)
Investments, 11th Edition (exclude Access Card)
11th Edition
ISBN: 9781260201543
Author: Zvi Bodie Professor; Alex Kane; Alan J. Marcus Professor
Publisher: McGraw-Hill Education
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Chapter 16, Problem 12CP
Summary Introduction

To calculate: The change in price of the both strategy.

Introduction: The change in price is calculated by the modified duration and change in yield. Price change is product of the modified duration to the interest rates of the strategy. It simply shows the change of the prices compared to the initial value.

Expert Solution & Answer
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Answer to Problem 12CP

The change in price of strategy 1 is 4.14% and 3.59% of strategy 2 .

Explanation of Solution

Here, the formula of modified duration is given,

Modified duration = (Price change/ Initial price) / Yield change , the price change is calculated by this formula. Calculation of price change is given below,

For strategy 1 , there are three types of maturity periods, a) 5 years with modified duration is 4.83 and interest rates is 0.75 with $5 million investment in it, b) 15 years with modified duration is 14.35 and interest rates is 0.25 but investment in it is $0million, c) 25 years with modified duration of 23.81 with 0.50 interest rates and $5 million investment in it.

Now price change for 5 year’s maturity is given below,

  Price change = modified duration × interest rates

  = 4.83 × 0.75%= 3.6225%

Price change for 25 year’s maturity is given below,

  Price change = 23.81 × 0.50%                        =11.905%

Hence the total price change is given below,

  Net percentage change = ( 0.50 × 3.6225%) + ( 0.50 × 11.905%)                                        =4.14%

Hence percentage change in strategy 1 is 4.14%.

Calculate for strategy 2 , it consists only 15 year’s maturity period with 14.35 modified duration and $10 million investments in it.

  Price change = 14.35 × 0.25%                         =3.5875%

Hence change in price of strategy 2 is 3.59%.

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