Question 4b
You will get this Formula Table at the exam so learn well how to apply it in your AFM (P4) Exam
GNT Co is considering an investment in one of two corporate bonds. Both bonds have a par value of $1,000 and pay coupon interest on an annual basis. The market price of the first bond is $1,079.68. Its coupon rate is 6% and it is due to be redeemed at par in five years.
The second bond is about to be issued with a coupon rate of 4% and will also be redeemable at par in five years. Both bonds are expected to have the same gross redemption yields (yields to maturity) The yield to maturity of a company’s bond is determined by its credit rating.
GNT Co considers duration of the bond to be a key factor when making decisions on which bond to invest.
Required:
Discuss how useful duration is as a measure of the sensitivity of a bond price to changes in interest rates. (8 marks)