COMM 324

INVESTMENTS AND PORTFOLIO MANAGEMENT

ASSIGNMENT 3

Alexander Cupillari 10101007

Bhavik Vyas 10086802
Oren Redinger 10103228
Azizali Shivji 10103387

Due: March 2

1. Consider a bond with the annual coupon payments of $100, a principal payment of $1000 in
15 years, and a cost of $1000. Assume a flat yield curve with a 5% yield to maturity. What
is the duration of the bond? If the yield curve remains unchanged, what is the bond’s
duration in three years? In five years? In eight years?

Duration at Yr = 0
Tim
e Weighting YTM 5% Duration at Yr = 0
Tim
0 1518.98 W*T e Weighting YTM 0.05
1 -100 -0.062698716 -0.062698716 0 1518.98 W*T
2 -100 -0.059713063 -0.119426125 1 -100 =(C4/(1+$F$2))/$C$3 =B4*D4
3 -100 -0.056869583 -0.17060875 2 -100 =(C5/(((1+$F$2))^B5)/$C$3) =B5*D5
4 -100 -0.054161508 -0.216646032 3 -100 =(C6/(((1+$F$2))^B6)/$C$3) =B6*D6
5 -100 -0.051582389 -0.257911943 4 -100 =(C7/(((1+$F$2))^B7)/$C$3) =B7*D7
6 -100 -0.049126084 -0.294756506 5 -100 =(C8/(((1+$F$2))^B8)/$C$3) =B8*D8
7 -100 -0.046786747 -0.327507229 6 -100 =(C9/(((1+$F$2))^B9)/$C$3) =B9*D9
=B10*D1
8 -100 -0.044558807 -0.356470454 7 -100 =(C10/(((1+$F$2))^B10)/$C$3) 0
=B11*D1
9 -100 -0.042436959 -0.381932629 8 -100 =(C11/(((1+$F$2))^B11)/$C$3) 1
=B12*D1
10 -100 -0.040416151 -0.404161512 9 -100 =(C12/(((1+$F$2))^B12)/$C$3) 2
=B13*D1
11 -100 -0.038491573 -0.423407298 10 -100 =(C13/(((1+$F$2))^B13)/$C$3) 3
=B14*D1
12 -100 -0.036658641 -0.439903687 11 -100 =(C14/(((1+$F$2))^B14)/$C$3) 4
=B15*D1
13 -100 -0.034912991 -0.453868883 12 -100 =(C15/(((1+$F$2))^B15)/$C$3) 5
=B16*D1
14 -100 -0.033250468 -0.465506547 13 -100 =(C16/(((1+$F$2))^B16)/$C$3) 6
=B17*D1
15 -1100 -0.348338232 -5.225073483 14 -100 =(C17/(((1+$F$2))^B17)/$C$3) 7
=B18*D1
15 -1100 =(C18/(((1+$F$2))^B18)/$C$3) 8
Duratio
n 9.599879794
Duratio
n =-SUM(E4:E18)
 Duration at Yr = 3
Tim 5
e Weighting YTM %
W*T Duration at Yr = 3
- Tim
1 -100 -0.065992749 0.065992749 e Weighting YTM 0.05
-
2 -100 -0.062850237 0.125700474 W*T
-
3 -100 -0.059857368 0.179572105 1 -100 =(J4/(1+$F$2))/$J$19 =I4*K4
4 -100 -0.057007018 -0.22802807 2 -100 =(J5/(((1+$F$2))^I5)/$J$19) =I5*K5
-
5 -100 -0.054292398 0.271461988 3 -100 =(J6/(((1+$F$2))^I6)/$J$19) =I6*K6
-
6 -100 -0.051707045 0.310242273 4 -100 =(J7/(((1+$F$2))^I7)/$J$19) =I7*K7
-
7 -100 -0.049244805 0.344713636 5 -100 =(J8/(((1+$F$2))^I8)/$J$19) =I8*K8
-
8 -100 -0.046899814 0.375198515 6 -100 =(J9/(((1+$F$2))^I9)/$J$19) =I9*K9
- =(J10/(((1+$F$2))^I10)/ =I10*K1
9 -100 -0.04466649 0.401998409 7 -100 $J$19) 0
- =(J11/(((1+$F$2))^I11)/ =I11*K1
10 -100 -0.042539514 0.425395142 8 -100 $J$19) 1
- =(J12/(((1+$F$2))^I12)/ =I12*K1
11 -100 -0.040513823 0.445652054 9 -100 $J$19) 2
- =(J13/(((1+$F$2))^I13)/ =I13*K1
12 -1100 -0.424430527 5.093166329 10 -100 $J$19) 3
=(J14/(((1+$F$2))^I14)/ =I14*K1
11 -100 $J$19) 4
Duratio 8.26712174 =(J15/(((1+$F$2))^I15)/ =I15*K1
n 6 12 -1100 $J$19) 5

Duratio
Price 1443.16 n =-SUM(L4:L15)

Price 1443.16

Duration at Yr = 5
YT
Time Weighting M #
W*
T Duration at Yr = 5
Tim 0.0
1 -100 -0.0687 -0.1 e Weighting YTM 5
2 -100 -0.0654 -0.1 W*T
3 -100 -0.0623 -0.2 1 -100 =(P4/(1+$F$2))/$Q$18 =O4*Q4
=(P5/(((1+$F$2))^O5)/
4 -100 -0.0594 -0.2 2 -100 $Q$18) =O5*Q5
=(P6/(((1+$F$2))^O6)/
5 -100 -0.0565 -0.3 3 -100 $Q$18) =O6*Q6
=(P7/(((1+$F$2))^O7)/
6 -100 -0.0538 -0.3 4 -100 $Q$18) =O7*Q7
=(P8/(((1+$F$2))^O8)/
7 -100 -0.0513 -0.4 5 -100 $Q$18) =O8*Q8
=(P9/(((1+$F$2))^O9)/
8 -100 -0.0488 -0.4 6 -100 $Q$18) =O9*Q9
=(P10/(((1+$F$2))^O10)/ =O10*Q
9 -100 -0.0465 -0.4 7 -100 $Q$18) 10
=(P11/(((1+$F$2))^O11)/ =O11*Q
# -1100 -0.4872 -4.9 8 -100 $Q$18) 11
=(P12/(((1+$F$2))^O12)/ =O12*Q
9 -100 $Q$18) 12
 Durati 7.2697377 =(P13/(((1+$F$2))^O13)/ =O13*Q
on 63 10 -1100 $Q$18) 13

Duratio
n =-SUM(R4:R13)
Price: 1386.09

Price: 1386.09

Duration at Yr = 8
Tim YT 5
e Weighting M %
W*
T
-
1 -100 -0.07 0.07
-
2 -100 -0.07 0.14
-
3 -100 -0.07 0.20
-
4 -100 -0.06 0.26
-
5 -100 -0.06 0.30
-
6 -100 -0.06 0.35
-
7 -1100 -0.61 4.24

Durati 5.5662014
on 27

Price 1289.32

Duration at Yr = 8
Ti 0.0
me Weighting YTM 5
W*T
1 -100 =(W4/(1+$F$2))/$X$14 =V4*X4
=(W5/(((1+$F$2))^V5)/
2 -100 $X$14) =V5*X5
=(W6/(((1+$F$2))^V6)/
3 -100 $X$14) =V6*X6
=(W7/(((1+$F$2))^V7)/
4 -100 $X$14) =V7*X7
=(W8/(((1+$F$2))^V8)/
5 -100 $X$14) =V8*X8
=(W9/(((1+$F$2))^V9)/
6 -100 $X$14) =V9*X9
=(W10/(((1+$F$2))^V10)/ =V10*X
7 -1100 $X$14) 10

Durati
on =-SUM(Y4:Y10)

Price 1289.32

2. A 25-year maturity, 8% coupon bond paying coupons semiannually is callable in 10 years at

a call price of $1,100. The bond sells at a yield to maturity of 6.5%, or 3.25% per half-year.
 a. What is the yield to call? At what yield to maturity would you expect the bond to be
called after ten years?
Cash Flow @ $1100 Yield to
Period Call a) Call YTM
0 1184.138
Semi
1 -40 Annual 3.12% 3.46%
2 -40 Annual 6.23% 6.92%
3 -40
4 -40
5 -40
6 -40
7 -40
8 -40
9 -40
10 -40
11 -40
12 -40
13 -40
14 -40
15 -40
16 -40
17 -40
18 -40
19 -40
20 -1140

b. What is the yield to call if the call price is only $1,050?

Cash Flow @ $1050

Call
1184.138 b) YTC
Semi-
-40 Annual 2.95%
-40 Annual 5.91%
-40
-40
-40
-40
-40
-40
-40
-40
-40
-40
-40
 -40
-40
-40
-40
-40
-40
-1090

3. Assume the following spot rate (zero-coupon) curve

Year 0.5 1.0 1.5 2.0 2.5
Zero Rate 7.0 (%) 7.45 7.8 8.5 9.0
a. If all bonds are priced consistently with this curve, what will be the price of a 2.5-
year semiannual, 12% coupon security?
b. What are the YTM and duration of this security?

Year 0.5 1 1.5 2 2.5 Total

Zero Rate 7% 7.45% 7.80% 8.50% 9%
Payments 60 60 60 60 1060
PV of 58.0041 55.8399 50.9673 854.554 1072.97
Payments 9 3 53.6072 2 2 3

0.05405 0.05204 0.04996 0.04750 0.79643

Weight 9 2 1 1 6 1
0.05204 0.07494 0.09500 2.24010
Weight*Time 0.02703 2 2 2 1.99109 6

1072.97
a) Price 3

b) YTM 4.345%
2.24010
Duration 6

c. If another bond also has 2.5-year, semiannual coupon, but the coupon rate of 13%.
Which one has a lower YTM? Which one has a shorter duration? Explain your
answer intuitively, and verify your answers through actual calculations.

The 2.5 year, 13% annual coupon will have a lower YTM because the rates close today are lower
because as yield curve is steep and the 13% coupon bond has more of its payments made closer to
today. Duration will also be lower as this bond will make its payments closer to today as it has a
higher coupon, thereby decreasing its duration.

Year 0.5 1 1.5 2 2.5 Total

Zero Rate 7% 7.45% 7.80% 8.50% 9%
Payments 75 75 75 75 1075
PV of 72.5052 69.7999 63.7091
Payments 4 1 67.009 5 866.647 1139.67
Price 1139.67

0.06361 0.06124 0.05879 0.05590 0.76043

Weight 9 6 7 1 7 1
0.06124 0.08819 0.11180 1.90109
Weight*Time 0.03181 6 5 3 1

YTM 4.333%
2.19414
Duration 5

4. A newly issued bond has a maturity of 20 years and pays a 6% coupon rate (with coupon
payments coming once annually). The bond sells at par.

4
Given
Maturity 20
Coupon 0.06
Price 1,000
YTM 0.06
Disc.
Rate 1.06
Duration
BOND
Time Until Discounted Tiime x
Payment Weight
Payment Payment Weight
1.06 1 $60.00 $56.60 0.057 0.057
1.06 2 $60.00 $53.40 0.053 0.107
1.06 3 $60.00 $50.38 0.050 0.151
1.06 4 $60.00 $47.53 0.048 0.190
1.06 5 $60.00 $44.84 0.045 0.224
1.06 6 $60.00 $42.30 0.042 0.254
1.06 7 $60.00 $39.90 0.040 0.279
1.06 8 $60.00 $37.64 0.038 0.301
1.06 9 $60.00 $35.51 0.036 0.320
1.06 10 $60.00 $33.50 0.034 0.335
1.06 11 $60.00 $31.61 0.032 0.348
1.06 12 $60.00 $29.82 0.030 0.358
1.06 13 $60.00 $28.13 0.028 0.366
1.06 14 $60.00 $26.54 0.027 0.372
1.06 15 $60.00 $25.04 0.025 0.376
1.06 16 $60.00 $23.62 0.024 0.378
 1.06 17 $60.00 $22.28 0.022 0.379
1.06 18 $60.00 $21.02 0.021 0.378
1.06 19 $60.00 $19.83 0.020 0.377
1.06 20 $1,060.00 $330.51 0.331 6.610
$1,000.00 1 12.15811649

Duration
BOND
Time Until Discounted
Payment Weight Tiime x Weight
Payment Payment
1.06 1 60 =(C12/B7^B12) =(D12/D32) =(B12*E12)
1.06 2 60 =(C13/B7^B13) =(D13/D32) =(B13*E13)
1.06 3 60 =(C14/B7^B14) =(D14/D32) =(B14*E14)
1.06 4 60 =(C15/B7^B15) =(D15/D32) =(B15*E15)
1.06 5 60 =(C16/B7^B16) =(D16/D32) =(B16*E16)
1.06 6 60 =(C17/A17^B17) =(D17/D32) =(B17*E17)
1.06 7 60 =(C18/A18^B18) =(D18/D32) =(B18*E18)
1.06 8 60 =(C19/A19^B19) =(D19/D32) =(B19*E19)
1.06 9 60 =(C20/A20^B20) =(D20/D32) =(B20*E20)
1.06 10 60 =(C21/A21^B21) =(D21/D32) =(B21*E21)
1.06 11 60 =(C22/A22^B22) =(D22/D32) =(B22*E22)
1.06 12 60 =(C23/A23^B23) =(D23/D32) =(B23*E23)
1.06 13 60 =(C24/A24^B24) =(D24/D32) =(B24*E24)
1.06 14 60 =(C25/A25^B25) =(D25/D32) =(B25*E25)
1.06 15 60 =(C26/A26^B26) =(D26/D32) =(B26*E26)
1.06 16 60 =(C27/A27^B27) =(D27/D32) =(B27*E27)
1.06 17 60 =(C28/A28^B28) =(D28/D32) =(B28*E28)
1.06 18 60 =(C29/A29^B29) =(D29/D32) =(B29*E29)
1.06 19 60 =(C30/A30^B30) =(D30/D32) =(B30*E30)
1.06 20 1060 =(C31/A31^B31) =(D31/D32) =(B31*E31)
=SUM(E12:E31
=SUM(D12:D31) ) =SUM(F12:F31)

Convexity
 Time Until 1/ CF/ (t^2+t) Product
Payment (Px(1+y)^2) (1+y)^t

1 0.00089 $56.60 2 $113.21

2 0.00089 $53.40 6 $320.40
3 0.00089 $50.38 12 $604.53
4 0.00089 $47.53 20 $950.51
5 0.00089 $44.84 30 $1,345.06
6 0.00089 $42.30 42 $1,776.50
7 0.00089 $39.90 56 $2,234.59
8 0.00089 $37.64 72 $2,710.42
9 0.00089 $35.51 90 $3,196.25
10 0.00089 $33.50 110 $3,685.41
11 0.00089 $31.61 132 $4,172.16
12 0.00089 $29.82 156 $4,651.63
13 0.00089 $28.13 182 $5,119.72
14 0.00089 $26.54 210 $5,572.99
15 0.00089 $25.04 240 $6,008.62
16 0.00089 $23.62 272 $6,424.31
17 0.00089 $22.28 306 $6,818.25
18 0.00089 $21.02 342 $7,189.05
19 0.00089 $19.83 380 $7,535.70
$138,815.4
20 0.00089 $330.51 420 6
0.0008 $209,244.7
9 8
186.2279

Convexity

Time Until 1/(Px(1+y)^2) CF/(1+y)^t (t^2+t) Product

Payment
1 0.00089 =D12 =(H12^2+H12) =(J12*K12)
2 0.00089 =D13 =(H13^2+H13) =(J13*K13)
3 0.00089 =D14 =(H14^2+H14) =(J14*K14)
4 0.00089 =D15 =(H15^2+H15) =(J15*K15)
5 0.00089 =D16 =(H16^2+H16) =(J16*K16)
6 0.00089 =D17 =(H17^2+H17) =(J17*K17)
7 0.00089 =D18 =(H18^2+H18) =(J18*K18)
8 0.00089 =D19 =(H19^2+H19) =(J19*K19)
9 0.00089 =D20 =(H20^2+H20) =(J20*K20)
10 0.00089 =D21 =(H21^2+H21) =(J21*K21)
11 0.00089 =D22 =(H22^2+H22) =(J22*K22)
12 0.00089 =D23 =(H23^2+H23) =(J23*K23)
13 0.00089 =D24 =(H24^2+H24) =(J24*K24)
14 0.00089 =D25 =(H25^2+H25) =(J25*K25)
15 0.00089 =D26 =(H26^2+H26) =(J26*K26)
16 0.00089 =D27 =(H27^2+H27) =(J27*K27)
17 0.00089 =D28 =(H28^2+H28) =(J28*K28)
18 0.00089 =D29 =(H29^2+H29) =(J29*K29)
19 0.00089 =D30 =(H30^2+H30) =(J30*K30)
20 0.00089 =D31 =(H31^2+H31) =(J31*K31)
0.00089 =SUM(L12:L31)
=(K32*L32)

a. What are the duration and convexity of the bond?

Duration Convexity
A) 12.15811649 186.2279

Duration Convexity
A) =F32 =L33

b. Find the actual price of the bond assuming that its yield to maturity immediately
increases from 6% to 7%

B) Current Price B) Current Price

$894.06 =-PV(0.07,20,60,1000)

c. What price would be predicted by the price-duration formula?

12.1581164
Duration 9
Change in y 1%
Change in 0.8784
Price 12.16% 0
New Bond
Price $878.40

Duration =F32
Change in y 0.01
Change in Price =(C41*0.01) =(1-0.1216)
New Bond Price =(D32*D43)
 d. What price would be predicted by the duration-with-convexity formula?
12.158116
Duration 5
Change in y 1%
Convexity 186.2279
New Bond -0.1029584 0.8970
Price 4
New Bond
Price $897.04

5. A 20-year bond has a 7% coupon rate, paid annually. It sells today for $867.42. A 10-year
bond has 6.5% coupon rate, also paid annually. It sells today for $879.50. A bond market
analyst forecasts that in 5 years, 15-year bond will sell at YTM of 8%, and 5-year bond will
sell at YTM of 7.5%. Because the yield curve is upward sloping, the analyst believes that
coupon will be reinvested in short term securities at a rate of 6%. What bond offers the
higher expected rate of return over the five year period?

Bond 1     Bond 2    
       
Maturity (years) 20   Maturity (years) 10  
Coupon 7%   Coupon 6.50%  
Price $867.42   Price $879.50  
       
Payment Coupon Re- Payment Coupon Re-
Schedule Payments invested Schedule Payment Invested
1 $70.00 $88.37 1 $65.00 $82.06
2 $70.00 $83.37 2 $65.00 $77.42
3 $70.00 $78.65 3 $65.00 $73.03
4 $70.00 $74.20 4 $65.00 $68.90
5 $70.00 $70.00 5 $65.00 $65.00
  $394.60   $366.41
       
Price of Bond $914.41   Price of Bond $959.54  
Cash Flows y1-5 $394.60   Cash Flows y1-5 $366.41  
  $1,309.00     $1,325.95  
Rate of Return 0.5091   Rate of Return 0.5076  

Therefore, the rate of return on the Bond #1 is higher.

Bond 1     Bond 2    
       
Maturity (years) 20   Maturity (years) 10  
 Coupon 0.07   Coupon 0.065  
Price 867.42   Price 879.5  
       
Payment Payment
Schedule Coupon Payments Re-invested Schedule Coupon Payment Re-Invested
1 70 =(B8*1.06^4) 1 65 =(F8*1.06^4)
2 70 =(B9*1.06^3) 2 65 =F9*1.06^3
3 70 =B10*1.06^2 3 65 =F10*1.06^2
4 70 =B11*1.06^1 4 65 =F11*1.06^1
5 70 =B12*1.06^0 5 65 =F12*1.06^0
  =SUM(C8:C12)   =SUM(G8:G12)
       
=- =-PV(0.075,
Price of Bond PV(0.08,15,70,1000)   Price of Bond 5,65,1000)  
Cash Flows y1-5 =C13   Cash Flows y1-5 =G13  
  =SUM(B15:B16)     =SUM(F15:F16)  
Rate of Return =(B17-B5)/B5   Rate of Return =(F17-F5)/F5  

6. You will be paying $10,000 a year in education expenses at the end of the year for
the next three years. Bonds currently yield 5%.
a. What is the present value and duration of your obligation?

Time to payment Outflow PV of outflow Weight

(years)
1 10000 =(10000)/(1+0.05)^1 =9523.80952/27232.48028
= 9523.80952 =0.34972
2 10000 =(10000)/(1+0.05)^2 =9070.29478/27232.48028
=9070.29478 =0.33306
3 10000 =(10000)/(1+0.05)^3 =8638.37598/27232.48028
=8638.37598 =0.31720
Total: 27232.48028 =1.00

Duration = (0.34972)(1)+(0.33306)(2)+(0.31720)(3)
= 1.96744

PV = $27232.48

b. What maturity of zero-coupon bond would immunize your obligation?

A zero-coupon bond maturing in 1.96744 years would immunize the obligation. This is because
the future value of the bond would = (27232.48028)(1.05)^(1.96744) = $29976.15131.
 c. Suppose you buy a zero-coupon bond with value and duration equal to your
obligation. Now suppose that rates immediately increase to 6%. What happens
to your net position, that is, to the difference between the value of the bond and
that obligation? What if rates fall to 4%?

If the rate increases to 6%, the value of the zero-coupon bond would change to =
(29976.15131)/(1.06)^(1.96744) = $26729.3317.

The PV of the tuition obligation would change to =(10000)/(1+0.06)^1 + (10000)/(1+0.06)^2 +

(10000)/(1+0.06)^3= $26730.11949.

The net position decreases by $0.78779.

If the rate decreases to 4%, the value of the zero-coupon bond would change to =
(29976.15131)/(1.04)^(1.96744) = $27750.05186.

The PV of the tuition obligation would change to = (10000)/(1+0.04)^1 + (10000)/(1+0.04)^2 +

(10000)/(1+0.04)^3= $27750.91033.

The net position decreases by $0.85846.

7. A member of a firm's investment committee is very interested in learning about the

management of fixed income portfolios. He would like to know how fixed-income
managers position portfolios to capitalize on their expectations concerning three
factors that influence interest rates:
a. Changes in the level of interest rates

If the level of interest rates is expected to change, the management should conduct a rate
anticipation swap, either to lengthen the duration (if rates are expected to fall), or shorten
the duration (if rates are expected to rise).

b. Changes in yield spreads across/between sectors

If there is an expected change in yield spreads across sectors, management should

conduct an intermarket spread swap. This involves the manager buying bonds in the
sector where yields are going to fall (relative to other bonds) and selling bonds in the
sector where yields are expected to rise (relative to other bonds).

c. Changes in yield spreads as to a particular instrument. Assuming that no

investment policy limitations apply, formulate and describe a fixed-income
portfolio management strategy for each of these factors that could be used to
exploit a portfolio manager's expectations about that factor. (Note: Three
strategies are required, one for each of the listed factors.)of your education
If the yield spread on a particular instrument is expected to change, management should
conduct a substitution swap. This involves the manager selling the instrument if the yield
is expected to rise (relative to the yield of similar bonds), or buying the instrument if the
yield is expected to drop (relative to the yield of similar bonds).

8. Assume liabilities of $200, $250, and $400 must be met at the end of year 1, 2, and 3,
respectively. Find a portfolio of bonds listed below that meets these cash outflows.

CF
Bond Price 1 2 3
A 930 30 1030
B 1000 100 100 1100
C 920 1000

Cash Flow
Bond Price 1 2 3
$ $ $ $
A 930.00 30.00 1,030.00 -
$ $ $ $
B 1,000.00 100.00 100.00 1,100.00
$ $ $ $
C 920.00 1,000.00 - -

Cash Flow Cash Flow Cash Flow

Weighting Option #1 1 2 3
$ $ $ $
30.00% 930.00 9.00 309.00 -
$ $ $ $
36.50% 1,000.00 36.50 36.50 401.50
$ $ $ $
33.50% 920.00 335.00 - -
$ $ $
100.00%   380.50 345.50 401.50

$
Total Cost 952.20

Therefore, a possible allocation is 30% of Bond A, 36.5% of Bond

B, and 33.5% of Bond C. This yields cash flows of $380.50 in year
1, $345.50 in year 2, and $401.50 in year 3.
 9. Assume that the following hypothetical treasury securities are currently available
in market:

Bond Coupon Maturity Yield to Maturity Modified duration

(in years)
A 8.5 5 8.5 4.005
B 9.5 20 9.5 8.882

You expect that the yield curve will flatten, but you have no clue as to whether
the overall interest rates will rise or fall. Use the two securities to suggest a trade
that is consistent with your expectations.

A flat yield curve implies that investors expect interest rates in the short term to remain
constant in the future. It can be deduced that both securities were bought at face value
(both coupon rate and YTM are the same), resulting in the present value of both bonds
being $1000.

In this scenario where interest rates rise, intuition suggests that it is better to purchase
more of the Bond A. If we are able to predict that interest rates will fall, the portfolio
would be better off having more of Bond B as it has a longer time to maturity/duration.

If the interest rate decreased by 1.5%:

 Price of Bond B increases by -8.882 x -.015 = 13.32%

 Price of Bond A increases by -4.005 x -.015 = 6.01%

If the interest rate increases by 1.5% it is better to allocate a heavier portion of the
portfolio to Bond A. This is because:

 Bond A would lose -4.005 x .015 = -6.01% instead of -8.882 x .015 = -13.32%

This means that a short position for Bond A would be entered and a long position for
Bond B would be entered because if the interest rate increases, the increase in the price of
Bond B will be offset by the loss in Bond A. In a situation where the interest rate rises
and prices fall, Bond A will be a hedge to the decrease in price.