Consider a five-year, 8 percent annual coupon bond selling at par of $1,000. If interest rates increase by 20 basis points, what is the approximate change in the market price using the duration approximation?

Question

Quizplus · Accepted Answer

The bond's duration can be used to estimate the price change. The duration of a 5-year bond with an 8% coupon is approximately 4.5 years. A 20 basis point increase in interest rates (0.002) would decrease the bond's price by approximately 4.5 * 0.002 * $1,000 = $9. However, since the bond is selling at par, the convexity effect slightly reduces this estimate, leading to an approximate price change of -$7.985.

Consider a Five-Year, 8 Percent Annual Coupon Bond Selling at Par