If a bond's modified duration is 4 and the interest rate goes down by 1% then the price of the bond:
decreases by 8% |
||
decreases by 4% |
||
increases by 8% |
||
increases by 4% |
Solution:
As per the information given in the question
The Modified Duration of the bond = 4 years
The Interest rate and price of a bond are inversely related. This relationship is explained by the modified duration of the bond.
Inference for Modified Duration:
For every one percentage increase in the interest rate, price of the bond will decrease by the ( Modified Duration * percentage of increase in interest rate )
For every one percentage decrease in the interest rate, price of the bond will increase by the ( Modified Duration * percentage of decrease in interest rate )
As per the information given in the question the interest rate decreases by 1 %
Thus since the interest rate is decreasing by 1 % , the price of the bond will increase by
= 1 % * 4
= 4 %
The price of the bond will increase by 4 %
Thus the solution is Option d. increases by 4%
If a bond's modified duration is 4 and the interest rate goes down by 1% then...
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