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You own a fixed-income asset with a duration of four years. If the level of interest rates, which is currently 8.1%, goes down by 20 basis points, how much do you expect the price of the asset to go up (in percentage terms)

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Parrain

Answer: 0.74%

Explanation:

Change in price of a fixed-income asset is inversely related to a change in it's interest rates.

The price change is therefore formulated by;

Δ Price of Asset = -Δ * Δy

Δ = 4 years / ( 1 + i)

= 4 / ( 1 + 8.1%)

= 3.7

A basis points refers to 0.01%. So 20 basis points 0.2%.

Δ Price of Asset = -3.7 * -0.2%

= 0.0074

= 0.74%

Price of Asset increases by 0.75%