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Bank Alpha has an inventory of AAA-rated, 15-year zero-coupon bonds with a face value of $400
million. The bonds currently are yielding 9.5 percent in the over-the-counter market.

a. What is the modified duration of these bonds?

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b. What is the price volatility if the potential adverse move in yields is 25 basis points?

c. What is the DEAR?

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d. If the price volatility is based on a 99 percent confidence limit and a mean historical change in
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daily yields of 0.0 percent, what is the implied standard deviation of daily yield changes?

Step-by-step solution

Step 1 of 4

a.

The modified duration of the bond can be calculated in following manner:

Thus the modified duration is

Comment

Step 2 of 4

b.

Price volatility can be calculated as below:

Thus price volatility is

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Step 3 of 4

c.

Daily Earnings at Risk can be calculated in following way:

Therefore the Daily Earnings at Risk is

Here,

$ Value of position can be calculated as below:

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Step 4 of 4

d.

Since the adverse move will be calculated on the basis of normal distribution with 99%
confidence level. The probability factor from statistics is 2.33 as it will cover the 99% area and
only 1% chances will be left for the adverse movement.

Potential adverse move in yield (PAMY) at 1 percent can be calculated as below:

Thus, the standard deviation for these bonds is .

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