3
$\begingroup$

I heard that this kind of questions appear a lot in the interviews. Here is one I saw from Galssdoor: Price a bond with coupon rate 3%, yield 9% and maturity 10 years. What is the typical way to do the approximation?

$\endgroup$
  • $\begingroup$ It's a trick question, I'd like to believe. No compounding frequency is given for coupon rate and yield. $\endgroup$ – BCLC Oct 15 '14 at 9:12
  • $\begingroup$ yes you're right. but what if those information were provided. any typical method? $\endgroup$ – user3337625 Oct 16 '14 at 19:55
  • $\begingroup$ Maybe set up the summation and then state the values? The bond price is the sum of coupons* e^(-yield*time). Coupon is 3 dollars a year except at the end where it is 103. Yield is constant 9% a year and so is t: t is 1 throughout. $\endgroup$ – BCLC Oct 16 '14 at 20:09
  • $\begingroup$ I would just write the formula. $\endgroup$ – SmallChess Aug 13 '16 at 12:59
1
$\begingroup$

It might be more impressive to demonstrate that you have the tools and can use them. Go to the interview with a handheld calculator. The answer is a few keystrokes away.

$\endgroup$
1
$\begingroup$

consider your bond initially was at par (cpn=3%~=yld_0) and now answer the question what is the price change given new yld_1=9%. for a very dirty estimate use relationship between price change vs yield change and duration (~=10).for a less dirty estimate you'll need some educated guess on the level of convexity. have a look at closed formula of convexity of par bond. hope this helps.

$\endgroup$
  • $\begingroup$ thank you slava! i didn't think of using par bond before... $\endgroup$ – user3337625 Oct 16 '14 at 19:54
1
$\begingroup$

Back of envelope approach:

$dP \simeq \frac{\partial P}{\partial y} \times \Delta y$

You know that when $y=3\%$, $P=100$. So you can write

$P-100 \simeq \frac{\partial P}{\partial y} \times (c-y)$

and so

Price $\simeq$ 100 + Duration x (3%-9%).

Guess a duration of around 7.0 for a 10 year bond (they would assume that you would have a feel for this number).

So I get 100 - 7 x 6 = 100 - 42 = $58.

If I do this carefully assuming annual compounding then I get $61.5 which is in the same ball park. You can refine this using a second order correction but this would be an acceptable first guess that you can do without calculators.

$\endgroup$
0
$\begingroup$

Use Taylor Expansion to approx price changes for some variations in Yield. Guess the Duration to be less than Full maturity since its Paying coupons and go from there. First price it at Par.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.