Please answer both questions for Upvote. Ques 1 a) Explain the concept of durati
ID: 2615023 • Letter: P
Question
Please answer both questions for Upvote.
Ques 1
a) Explain the concept of duration.
b) Why is duration is thought of as a measure of risk?
c) If duration is a measure of risk, what would you do if interest rates are expected to rise (assume you want to be fully invested in bonds). Would you buy bonds with shorter or longer durations?
Ques 2
Assume an inflation protection bond (TIPS) with 30 years remaining to expiration carries a coupon rate of 4.25% and is sold for $900. The par value of the bond is $1,000. Complete the table below and show all calculations in each cell.
YR
Inflation
Interest
Received
Accrued
Principal value
Interest earned due to inflation
Total return
ROR
(Nominal)
Real
ROR
1
3.0%
2
2%
3
1 %
4
Minus 1%
It is a negative rate of inflation
YR
Inflation
Interest
Received
Accrued
Principal value
Interest earned due to inflation
Total return
ROR
(Nominal)
Real
ROR
1
3.0%
2
2%
3
1 %
4
Minus 1%
It is a negative rate of inflation
Explanation / Answer
Duration is the measure of the period for which the particular bond takes to recover its investment
Duration is the measure of the risk because the bond should recover its investment with in shorttime, if time period for the period of recovery is high, the investors tries to invest in the other bonds which gives recovery of amount invested in the short time.
Interest rates are expected to increase, it is advisable to buy the bond now and sell it in future, Because the amount we invested will be recovered in the lessor time in the form of interest.