Your portfolio contains 40% of Bond I, 20% of Bond II, 20% of Bond III and 20% of Bond IV. Details of the four bonds are given below: Bond 1: 10-year zero coupon government bond, par value $1000, current price = 613.91 Bond 11: 10-year zero coupon AA rated bond, par value $1000, default risk premium 2% Bond III: 5 year 15% coupon, BBB rated bond, par value $1000, annual coupon payments default risk premium =10% Bond IV: 5 year 15% government coupon bond, par value $1000, annual coupon payments, YTM=6%
(a) (4 marks) Find the price of Bond II, III, and IV, respectively.
(b) (6 marks) Find the Macaulay’s duration of Bond I, II, III and IV, respectively,
(c) (2 marks) What is the duration of your portfolio by using your answers in the part (b)?
(d) (2 marks) If you forecast that yield curve will shift upwards in the near future, how can you adjust your portfolio to minimize the effect on your portfolio?
(e) (4 marks) If Bond I’s yield decreases by 1%, what is the price of Bond I based on duration- with-convexity rule? Assume the convexity of the Bond 18 99.77 (0) (2 marks) Brietly explain how duration and convexity affect your bond investments.