CFA Level II ExamFixed IncomeEasy
An investor owns a bond with a 5-year maturity, a 6% annual coupon, and a yield to maturity of 5%. The bond's modified duration is 4.3 years. If the yield to maturity increases by 100 basis points, what is the approximate percentage change in the bond's price?
- A-6.00%
- B-5.50%
- C-4.30%
- D-0.43%
Show answer & explanationAnswer & explanation
Correct answer: C. -4.30%
The approximate percentage change in bond price can be calculated using the modified duration formula: %ΔPrice ≈ -Modified Duration × ΔYTM. In this case, %ΔPrice ≈ -4.3 years × 0.01 = -0.043 or -4.30%.
Why the other options are wrong
- A. This is an incorrect calculation, possibly confusing coupon rate with price change.
- B. This is an incorrect calculation; it might involve misunderstanding the units or formula.
- D. This answer incorrectly uses 0.10 for the yield change instead of 0.01.
Modified Duration Price Change
Modified duration estimates the percentage change in a bond's price for a 1% (100 basis point) change in its yield to maturity.
- Formula: %ΔPrice ≈ -Modified Duration × ΔYTM.
- ΔYTM must be expressed as a decimal (e.g., 100 bps = 0.01).
- Provides a linear approximation, more accurate for small yield changes.
Memory trick: Duration Delivers Direct Price Direction.