Pilot (pre 2007)
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Question 4b

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)