The duration of a 2 year annual 10% bond that is selling for par is:
A) 2.00 years
B) 1.00 years
C) 1.91 years
D) 2.09 years

Question

Quizplus · Accepted Answer

The duration of a bond is a measure of the sensitivity of its price to changes in interest rates, which can be calculated using the formula for Macaulay duration. For a 2-year annual 10% bond selling at par, the duration is less than its maturity because the bondholder receives interest payments before the bond's maturity, which reduces the bond's sensitivity to interest rate changes. The correct calculation involves discounting each cash flow by the yield (in this case, 10% since the bond is selling at par) and then calculating the weighted average time until each payment is received. The calculation would show that the duration is approximately 1.91 years, indicating that on average, the bond's cash flows are received earlier than the bond's maturity.

The Duration of a 2 Year Annual 10% Bond That