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CA Final · Advanced Financial Management · Security Valuation

A bond issued by Kaveri Power Ltd. trades at Rs 1,000 with a yield to maturity of 5% p.a. (annual compounding). Its Macaulay duration is 4.2 years. If the yield rises immediately by 50 basis points, what is the approximate new price using duration alone?

The new price is about Rs 980. Modified duration is 4.2 divided by 1.05, which is 4.0. A 0.5% rise in yield lowers the price by roughly 2%, or Rs 20 on Rs 1,000. Using Macaulay duration directly would overstate the fall.

  1. ARs 980Correct
  2. BRs 979
  3. CRs 1,020
  4. DRs 1,021

Explanation

Modified duration = 4.2 / 1.05 = 4.0. Percentage price change = -4.0 x 0.005 = -2.0%, so the price falls by Rs 20 to about Rs 980. Rs 979 results from wrongly using Macaulay duration (4.2 x 0.5% = 2.1%) without dividing by (1+y). Rs 1,020 and Rs 1,021 get the direction wrong.

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