Question

A bond has a MacD of 14.6, ModD of 13.8 and DV01 of $2.5. Suppose its yield to maturity goes down one percentage point (e.g., from 5% to 4%). Which of the following is most likely to be true? ​[Hint: 1% = 100 basis points]

A

The bond's price should decrease by approximately $14.6.

B

The bond's price should increase by approximately $13.8.

C

The bond's price should increase by approximately $2.5.

D

The bond's price should increase by approximately 13.8%.

E

The bond's price should increase by approximately 14.6%.

Answer 1

D. The bond's price should increase by approximately 13.8%.

Modified duration (ModD) is approximately equals to percentage change bond prices if yield to maturity change by 1%. Further, yield to maturity and Bond price is inversely related which means if ytm decreases then price of bond increases.

Thus, in above case, ModD is 13.8% and ytm decreases by 1% thus, Bond's price should increases by approx 13.8%.

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.