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Finance Problem Sets Essay

¶ … bond pays you $1,000 at the end of this year (Year 1) and $1,500 at the end of Year 2. The current one-year spot rate is 4% and the current two-year spot rate is 4.5%. Calculate the duration of this bond. Use DURATION function on Excel ?

Using the partial durations calculated in #4a, how much would the bond's price change if the one-year spot rate decreased by 100 basis points and the two-year spot rate dropped 50 basis points?

Percentage price change = - Duration x Yield change x 100

-2.6 * -0.01 * 100 = 2.6% increase for r1 =3%,

-0.005 * 100 = 1.3% increase...

Similarly, f3= 7.1%, f4 = 7.3%, f5 = 8.2%. What are the spot rates r2, r3, r4, and r5?
(1+r (0,2))2 = (1+r (0,1)) x (1+f (1,2))1, (1+.06) x (1+.064) = 1.12784, (1.12784) 1/2 = 1.061998,

1.061998 -1 = 6.1998% ? 6.2% = r2

(1+r (0,3))3 = (1+r (0,2))2 x (1+f (2,3))1, (1+.061998)2 x (1+.071) = (1.12784) x (1.071) = 1.20791664, (1.20791664) 1/3 = 1.06499, 1.06499-1 = 6.499% ? 6.5% = r3

(1+r (0,4))4 = (1+r (0,3))3 x (1+f (3,4))1, (1+.06499)3 x…

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