Question

Philip Morris has issued bonds that pay semiannually with the following characteristics:

Answer 1

Answer:

a)  ≈  9.6 years

b)   Modified duration is a better measure because Modified duration consider the concept of negative convexity

c) i) coupon of bond = 4%

  Modified duration will increase since the coupon rate of payment decreased

ii) Maturity of bond = 7

 Modified duration will decline as Maturity period has declined to 7 years

Explanation:

A) Calculate modified duration using the preceding information

modified duration = Macaulay duration / ( 1 + (yield to maturity / 2 ))

                             = 10 / ( 1 + ( 0.08 / 2 ))

                             = 9.615 years

B) Modified duration is a better measure because Modified duration consider the concept of negative convexity while Macaulay methods shows the inverse relationship between the duration of the bond and coupon payment .

C) Determine Direction of change in modified duration if

i) coupon of bond = 4%

  Modified duration will increase since the coupon rate of payment decreased

ii) Maturity of bond = 7

 Modified duration will decline as Maturity period has declined to 7 years