MR. Hassan is a well-educated person who works in a private company as an accountant. Last week he inherited 1 million rupees from his aunt’s property. He is basically a risk averse investor. Stock market is much riskier than bond market. So he wants to select a bond for investment. For this purpose, as a part of bond analysis, he calculated the duration of bonds. He has two bonds as investment options.
a) The par value of Bond A is Rs.100, coupon rate is 10%, maturity period is 10 years and yield is 12%.
b) Bond B is 3-years zero coupon bond. Its face value is Rs.100 and currently it can be purchased at Rs.75.
You are required to find out the
(I) Macaulay duration and Modified duration in both cases.
(II) Also explain what modified duration shows in both cases and which bond has more price volatility risk?
Macaulay duration calculation for Investment in bond “A” & Bond “B”
Marks = 13
Modified Bond duration calculation for Investment decision in bond “A” & Bond “B” Marks = 4
Interpretation for Investment in bond “A” & Bond “B” Marks = 3