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Question: two defaultfree government bonds a and b are trading at...

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Two (default-free) government bonds, A and B, are trading at a current market price of $80 and $74, respectively. Bond A is a zero-coupon bond with 1 year to maturity. Bond B is a 10% coupon bond with 2 years to maturity. Both bonds have a face value of $100. Assume any coupons are paid annually.

 

(a)    Determine the 1-year and 2-year spot rates.

 

(b)    (i). What is the Macaulay Duration of Bond B at its yield to maturity?

 

(ii). Using the duration approach, approximate the dollar change in the price of the bond if its yield increases by 1 percentage point.

 

iii. Would the magnitude of this price change be larger or smaller if Bond B was currently selling at par? Explain without the aid of any calculations.

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