Explanation:
The formula for effective duration is: Effective Duration =
Where: = Price if yields fall = 278.935 = Price if yields rise = 272.650 = Initial price = 276.060 = Change in yield = 40 bps = 0.0040
Plugging in the values:
Effective Duration =
= $6.285 / 2.20848\approx 2.8458$
Rounding to two decimal places, we get 2.85.
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Q.10 A trader uses a model uses his valuation model to estimate the value of a bond portfolio at CAD 276.060 million. The term structure is flat. Using the same model, he estimates that the value of the portfolio would increase to CAD 278.935 million if all interest rates fell by 40 bps and would decrease to CAD 272.650 million if all interest rates rose by 40 bps. Using these estimates, determine the effective duration of the bond.
A
2.85
B
0.028
C
0.023
D
0.285
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