An Assignment On

“Duration Calculation”

Course Title: Intermediate Finance

Prepared for,
Professor Dr. S. M. Ikhtiar Alam
Course instructor
FIN 512: Intermediate Finance
IBA-JU

Prepared by,
G.M. Sharmin Laila
ID-1888
MBA 25th Batch
Date of submission: 18th November, 2020

Institute of Business Administration

Jahangirnagar University
Question: Make a portfolio with 3 bonds, calculate the duration of
those bonds and then measure the amount of money how much should
invest on each bond.
Answer:
Let us take 03 bonds, Bond A, Bond B and Bond C. The features of these bonds are given below:

Bond Coupon Frequency Years to YTM (%) FV ($)

rate (%) maturity
A 8 Annually 4 5 1200
B 9 Annually 3 6 1000
C 10 Quarterly 2 7 1500

First, let us calculate the price and the duration of Bond A, Bond B and Bond C.

Bond A
t Cash flow, Ct PV of Ct at 5 % (3)/ Po [(3)/ Po] * t
(1) (2) (3) (4)
1 80 76.19048 0.059949 0.059949
2 80 72.56236 0.057094 0.114189
3 80 69.10701 0.054376 0.163127
4 1280 1053.059 0.828581 3.314323
PA=$1270.919 DA=3.6516
So, Price & Duration of Bond A are $1270.919 and 3.6516 years respectively.

Bond B
t Cash flow, Ct PV of Ct at 6 % (3)/ Po [(3)/ Po] * t
(1) (2) (3) (4)
1 90 84.90566 0.078602 0.078602
2 90 80.09968 0.074153 0.148307
3 1090 915.185 0.847244 2.541733
PB=$1080.19 DB=2.7686
So, Price & Duration of Bond B are $1080.19 and 2.7686 years respectively.
Bond C
In Bond C, frequency is given as quarterly. So, Coupon rate is (10÷2) =2.5%, YTM is (7÷4)
=1.75% and t=2×4=8.

t Cash flow, Ct PV of Ct at 7 % (3)/ Po [(3)/ Po] * t

(1) (2) (3) (4)
1 37.5 36.85504 0.023277 0.023277
2 37.5 36.22117 0.022877 0.045754
3 37.5 35.5982 0.022483 0.06745
4 37.5 34.98594 0.022097 0.088387
5 37.5 34.38422 0.021717 0.108584
6 37.5 33.79285 0.021343 0.128059
7 37.5 33.21164 0.020976 0.146833
8 1537.5 1338.258 0.84523 6.761837
Pc=$1583.307 DC=7.370181÷4
=1.8425
So, Price & Duration of Bond C are $1583.307 and 1.8425 years respectively.

Now, let’s make a portfolio with Bond A and Bond B.

Price of these bonds=$1270.919+$1080.19=$2351.11

Weighted duration of the Bonds: [(P0/Price of portfolio) *D]

Bond Calculation Weighted Duration
A ($1270.919/$2351.11)*3.651 1.973914
6
B ($1080.19/$2351.11)*2.7686 1.272001

Total duration of portfolio; Dp =1.973914+1.272001=3.2459

So, Wc=Dc /(Dp+ Dc) =1.8425/(3.2459+1.8425)=0.3621

And Wp= Dp /(Dp+ Dc) = 3.2459/(3.2459+1.8425)=0.6379
Wa = Da/ (Da +Db)* Wp =3.6516/(3.6516+2.7686)*0.6379=0.3628
Wb = Db/ (Da +Db)* Wp=2.7686/(3.6516+2.7686)*0.6379=0.2751

Here, Wa+Wb+Wc =0.3621+0.3628+0.2751=1 (Mathematical Logic Proved)

Now, let’s assume we need to invest a Capital Fund of $200,000 and we will invest in
bonds A, B, C according to their weight in the portfolio.
Bonds Weight of (1) * Capital Price of Number of Rounding off of Amount to
bonds Fund bonds, Po bonds to be the number of be invested
purchased = bonds to be = (5)*(3)
(2)/ (3) bought
(3) (6)
(1) (2)
(4) (5)

A 0.36 $72,000 $1270.919 56.65192 57 $72442.38

B 0.36 $72,000 $1080.19 66.65494 67 $72372.73

C 0.28 $56,000 $1583.307 35.36901 34 $53832.44

=$200,000 =$198647.6

Using our formula, we will invest $198647.6 or approximately $198648 in Bonds A, B

and C according to their weight.