As an inquisitive student of finance,you were sceptical when your lecturer told you that the price changes of bills could be accurately measured using the elasticity approach.Assuming a $100 000 face value 180-day bill with 45 days to maturity,calculate the pricing error from using the elasticity approach if the yield changes from 7% to 8.5% p.a.

Question

Quizplus · Accepted Answer

The original price of the bill can be found by inserting the face value of $100 000,a yield of 7% and 45-day maturity into equation 5.1,page 138.This results in a price of $99 144.37.To estimate the price change from the change in yield involves application of equation 5.8,page 144.Using the original price of $99 144.37,an elasticity measure of -1 and a % change in (1 + yield)of -0.00183 results in an estimated price change of $181.73.The actual price of the bill can be found by inserting the face value of $100 000,a yield of 8.5% and 45-day maturity into equation 5.1,page 138.This results in a price of $98 962.92.The actual price change is therefore $181.45,and hence the error from the elasticity approach is $181.45 - $181.73 = -$0.28.The negative sign of the error indicates that the estimate was less than the actual price change.

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