Question

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%

Answer 1

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%