Consider a security with a duration of 2.78 years.The current interest rate level is 10% per annum.How does the price of the security change if interest rates decrease by 100 basis points (round to two decimals)?
A)The price of the security will decrease by 1%.
B)The price of the security will increase by 1%.
C)The price of the security will decrease by 2.50%.
D)The price of the security will increase by 2.50%.

Question

Quizplus · Accepted Answer

The price of a bond moves inversely to changes in interest rates, meaning a decrease in interest rates will lead to an increase in bond prices. The price change can be calculated using the modified duration formula:

Price change = - Duration x ΔYield/(1 + Yield)

where ΔYield is the change in yield in decimal form. In this case, ΔYield = -0.01 (a decrease of 100 basis points). Plugging in the numbers:

Price change = -2.78 x (-0.01)/(1 + 0.10) = 0.025, or 2.50%

Therefore, the price of the security will increase by 2.50% if interest rates decrease by 100 basis points. The answer is D.

Consider a Security with a Duration of 2