Question

please explain the ans clearly, thanks

(a) Are the following statements true or false? Briefly explain your answer. i) “The duration of a zero-coupon bond equals its time to maturity.” ii) Holding maturity constant, a bond's duration is lower when the coupon rate is higher.” iii) “Holding other factors constant, the duration of a coupon bond is higher when the bond's yield to maturity is lower.” (12 marks) (b) “It is not possible to forecast stock returns in an efficient market.” (4 marks)

Answer 1

(a) i) True. Duration or Macaulay Duration can be defined as the weighted average term to maturity of the cash flows from a bond. In simple terms it's a measure of how long the initial outflow will be recovered. In case of a Zero Coupon Bond there is no coupon payments and entire amount is received on maturity. Since there is no interim cash inflows the weighted average time the bondholder would receive the cash flow is on Maturity. ii) True. When the coupon rate is high, the coupon amount received will be higher. Therefore the repayment will be done earlier compared to the bond with low coupon amount. Hence the duration will be lower. iii) True. Bond prices have an inverse relationship with interest rate i.e when interest rates are falling, bond prices will rise and vice versa. The more the price of the bond the longer it would take to recover and hence duration will be higher. (b) True. An efficient market means that the underlying asset price reflects all the available information and any deviation based on some unrevealed information is not predictable in advance.