University of Tunis

Tunis Business School

Principles of Finance
Tutorial n°6: Bonds, Duration and Convexity
Professor: Dr. Ridha Esghaier
(Spring 2021)

Multiple Choice Questions:

Q1. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's:
a. term-to-maturity is lower.
b. coupon rate is higher.
c. yield to maturity is lower.
d. current yield is higher.
e. None of these is correct.

Q2. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's:
a. term-to-maturity is lower.
b. coupon rate is lower.
c. yield to maturity is higher.
d. term-to-maturity is lower and yield to maturity is higher.
e. None of these is correct.

Q3. Which of the following is/are correct?

a. The duration of a bond is a function of the bond's coupon rate, time to maturity and yield to maturity,
b. Coupon reinvestment risk matters more when the investor has a long-term horizon relative to the time-
to-maturity of the bond.
c. Market price risk matters more when the investor has a short-term horizon relative to the time-to-
maturity
d. two investors holding the same bond can have different exposures to interest rate risk if they have
different investment horizons.
e. None of these is correct.
Q4. All else equal, the duration of a bond is positively correlated with the bond's
a. time to maturity.
b. coupon rate.
c. yield to maturity.
d. All of these are correct.
e. None of these is correct.
Q5. All else equal, the duration of a bond is negatively correlated with the bond's
a. time to maturity.
b. coupon rate.
c. yield to maturity.
d. coupon rate and yield to maturity.
e. None of these is correct.
Q6. The "modified duration" used by practitioners is equal to the Macaulay duration
a. times the change in interest rate.
b. times (one plus the bond's yield to maturity).
c. divided by (one minus the bond's yield to maturity).
d. divided by (one plus the bond's yield to maturity).
e. None of these is correct.
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Q7. The interest-rate risk of a bond is
a. the risk related to the possibility of bankruptcy of the bond's issuer.
b. the risk that arises from the uncertainty of the bond's return caused by changes in interest rates.
c. the risk caused by factors unique in the bond.
d. the risk related to the possibility of bankruptcy of the bond's issuer and the risk that arises from the
uncertainty of the bond's return caused by changes in interest rates.
e. All of these are correct.
Q8. Par value bond XYZ has a modified duration of 6. Which one of the following statements regarding
the bond is true?
a. If the market yield increases by 1% the bond's price will decrease by $60.
b. If the market yield increases by 1% the bond's price will increase by $50.
c. If the market yield increases by 1% the bond's price will decrease by $50.
d. If the market yield increases by 1% the bond's price will increase by $60.
e. None of these is correct.
Q9. A 9%, 16-year bond has a yield to maturity of 11% and duration of 9.25 years. If the market yield
changes by 32 basis points, how much change will there be in the bond's price?
a. 1.85%
b. 2.01%
c. 2.67%
d. 6.44%
e. None of these is correct.
Q10. Which one of the following par value bonds with 12% coupon experiences a price change of $23 when
the market yield changes by 50 basis points?
a. The bond with a duration of 6 years.
b. The bond with a duration of 5 years.
c. The bond with a duration of 2.7 years.
d. The bond with a duration of 5.15 years.
e. None of these is correct.

Q11. The duration of a par value bond with a coupon rate of 7% and a remaining time to maturity of 3
years is
a. 3 years.
b. 2.71years.
c. 2.81 years.
d. 2.91 years.
e. None of these is correct.
Q12. The curvature of the price-yield curve for a given bond is referred to as the bond's
a. modified duration.
b. duration.
c. sensitivity.
d. convexity.
e. tangency.

Q13. The variation of a bond price due to changes in the YTM based on both duration and convexity is
more precise than the one based on the duration solely, especially when the change in the YTM is:
a. very little
b. less than the coupon rate on the bond
c. high
d. zero
e. none of the above

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 Q14. Consider a bond selling at par with modified duration of 12 years and convexity of 265. A 1%
point decrease in yield would cause the price to increase by 12%, according to the duration rule. What
would be the percentage price change according to the duration-with-convexity rule?
a. 21.25%
b. 25.45%
c. 17.00%
d. 13.32%
e. None of these is correct.

Q15. The variation of a bond price due to changes in the YTM measured by the duration solely,
compared to the variation of the bond price based on both duration and convexity:
a. is the same
b. underestimates the increase in the bond’s price due to a decrease in the YTM
c. overestimates the increase in the bond’s price due to a decrease in the YTM
d. underestimates the decrease in the bond’s price due to an increase in the YTM
e. overestimates the decrease in the bond’s price due to an increase in the YTM

Exercise n°1: Source of return

An investor buys a four- year, 10% annual coupon payment bond priced to yield 5%. The investor plans
to sell the bond in two years once the second coupon payment is received. Calculate the purchase price
for the bond and the horizon yield assuming that the coupon reinvestment rate after the bond purchase
and the yield-to-maturity at the time of sale are : (1) 3%, (2) 5%, (3) 7%.

Exercise n°2: Duration Versus Duration-with-Convexity measures

Consider a 2-year semiannual bond with an 8% coupon rate with a 10% YTM.
(a) Calculate the duration and the modified duration of this bond.
(b) According to the duration, what will be the change in the price of this bond due to an
increase of the YTM by 3% point?
(c) Compute the actual variation in the bond price using the full valuation technique
(d) Compute the convexity of this bond. What will be the variation of the price of the bond
according to the duration-with-convexity rule? Compare the results of (b), (c) and (d)

Exercise n°3: Duration Versus Duration-with-Convexity measures

Consider a bond that has a 30-year maturity, an 8% coupon rate, and sells at an initial
yield to maturity of 8%. Because the coupon rate equals the yield to maturity, the bond originally
sells at par value: $1,000. Also, you are told that the modified duration (Dm) of the bond, at its
initial yield, is 11.26 years, and that the bond’s convexity is 212.4. Suppose that the bond’s
yield increases from 8% to 10%.
(a) Predict how much the bond price would decline by applying the duration rule.
(b) Compute the percentage change in the bond price due to the 2% increase of the YTM
using the full valuation approach. Can you explain differences with the result in item (a)?
(c) Now consider that you are interested in predicting how much the bond price would
change by applying the duration-with-convexity rule. How do you analyze the result in this case?
(d) Now consider that there is a much smaller change in bond’s yield of 0.1%, so that the
price of the bond would actually fall to $988.85, which corresponds to a decline of 1.115%.
Predict how much the bond price would change by applying both the duration and the duration-
with convexity rules, and then analyze how the results differ from those in (a) and (c).

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