ABC Corporation has 4-year, 5% annual coupon bonds outstanding. Given a 6.5% yield to maturity, determine the duration of these bonds.

Question

Quizplus · Accepted Answer

Duration measures the sensitivity of a bond's price to changes in interest rates, typically calculated as the weighted average time to receive the bond's cash flows. For a bond with a 4-year maturity, a 5% annual coupon, and a yield to maturity of 6.5%, the duration will be less than its maturity because the bond pays coupons before maturity, which means the investor receives some of the investment before the bond's final maturity. The correct duration of 3.52 years (option C) suggests that on average, the bond's cash flows are received in 3.52 years, taking into account the time value of money and the bond's coupon payments and final principal repayment. Calculating the exact duration involves a present value calculation of each cash flow, weighted by the time until the cash flow occurs, and then summing these values.

ABC Corporation Has 4-Year, 5% Annual Coupon Bonds Outstanding