Question

(a) A newly issued Irish government bond has a maturity of 5 years and pays a 2% coupon rate (annually). The bond sells at par value of €100. (i) Explain, using formulas, how the concept of bond maturity differs from the concepts of Macaulay duration, modified duration and convexity. (ii) Why might you be willing to pay more for a bond with extra convexity? Illustrate your answer with a diagram. (iii) Calculate the duration and convexity of the above bond. (12 marks) (b) Explain bond portfolio immunisation. What conditions are necessary to ensure a successful immunisation strategy? (5 marks) (c) Analyse the rationale for each of the following in managing a passive bond portfolio: Matching duration Matching the distribution of cash flows Stratifying the index on multiple dimensions (iv) Matching contribution to duration by sector and issuer (8 marks)

Answer 1

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