vA $1,000 three-year par-value bond yields an effective annual interest rate of 6%. Coupons are paid on an annual basis at a rate of 5% per year. Determine the modified convexity of the bond

10.00

Explanation:

We haven = 3

Pv = 1000

Rate if interest = 6%

Coupon = 5% x 1000

= 50

∆y = assumed to be 1%

The formula for convexity =

(V- + V+)-2Vo/Vo+(∆y)²

We first solve for Vo

Using the financial calculator

Vo = 973.26

Then we solve for V-

Pv = 1000

Pmt = 50

I = 5%

n = 3

V- = 1000

We solve for V+

I = 7%

Pmt = 50

N = 3

V+ = 947.51

Then the convexity is gotten by putting these values into the formula

= (1000+947.51)-2x973.26/973.26x(1%)²this is approximately

10

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