Original practice · fully worked
Original variant: duration of a uniformly delayed investment
Investment A has modified duration 3.4 years at an annual effective yield of 8%. Investment B pays exactly the same amounts as Investment A, but every payment occurs two years later. Determine Investment B's modified duration.
- A
4.97 - B
5.10 - C
5.25 - D
5.40 - E
5.55
Answer and calculation
A two-year uniform delay adds 2 divided by 1.08 to modified duration. Investment B therefore has modified duration 5.25185, choice C.
Setup
Setup
A uniform two-year delay multiplies the entire price function by one plus i to the negative second power.
PB(i)=PA(i)(1+i)−2 Model
Model
Take the negative logarithmic derivative of the product.
Dmod,B=Dmod,A+1+i2 Compute
Compute
Insert the given duration and yield.
Dmod,B=3.4+1.082=5.251852 Answer
Answer
The delayed investment's modified duration is 5.25, choice C.
Dmod,B≈5.25(C)