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CMA Final · Strategic Financial Management · Risks in Financial Market

A treasury holds a bond with Macaulay duration of 4.2 years and yield to maturity of 8% p.a. compounded annually. Its market value is Rs 10 crore. If yield rises by 50 basis points, the approximate change in value using modified duration is closest to:

The value falls by about Rs 19.44 lakh. Modified duration is 4.2 divided by 1.08, or 3.889; multiplied by a 0.5% yield rise it gives a 1.944% decline on Rs 10 crore. Using Macaulay duration directly would wrongly give Rs 21 lakh.

  1. ADecrease of Rs 19.44 lakhCorrect
  2. BIncrease of Rs 19.44 lakh
  3. CDecrease of Rs 21.00 lakh
  4. DDecrease of Rs 20.19 lakh

Explanation

Modified duration = 4.2/1.08 = 3.8889. Percentage change = -3.8889 x 0.005 = -1.9444%. On Rs 10 crore, fall = Rs 19.44 lakh. Rs 21.00 lakh uses Macaulay duration directly (4.2 x 0.5%). An increase has the wrong sign.

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