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The following table shows the market information of three bonds: Market price Macaulay duration Modified convexity Bond A 96.3701 3.8250 17.4158 Bond B 100 6.2421 44.3612 Bond C 109.3851 9.4408 103.867 (*Note: The duration and convexity in the above table are calculated based on the annual effective yield rates of the bonds) The term structure of interest rate is assumed to be flat and the annual effective interest rate is currently io = 4%. Questions (a) We consider a portfolio consists of 1 unit of bond A, 2 units of bond B and 1 unit of bond C. Using first-order approximation, estimate the percentage change in bond price when the annual effective interest rate drops by 0.15%. (b) Suppose that the investor wishes to invest his wealth into these 3 bonds for 7 years and construct a portfolio such that the IRR of the investment is at least io = 4%, determine the best portfolio for the investor. Provide full justification to your answer. (Hint: Let W be the initial wealth of the investor. Express your answer in terms of W.) The following table shows the market information of three bonds: Market price Macaulay duration Modified convexity Bond A 96.3701 3.8250 17.4158 Bond B 100 6.2421 44.3612 Bond C 109.3851 9.4408 103.867 (*Note: The duration and convexity in the above table are calculated based on the annual effective yield rates of the bonds) The term structure of interest rate is assumed to be flat and the annual effective interest rate is currently io = 4%. Questions (a) We consider a portfolio consists of 1 unit of bond A, 2 units of bond B and 1 unit of bond C. Using first-order approximation, estimate the percentage change in bond price when the annual effective interest rate drops by 0.15%. (b) Suppose that the investor wishes to invest his wealth into these 3 bonds for 7 years and construct a portfolio such that the IRR of the investment is at least io = 4%, determine the best portfolio for the investor. Provide full justification to your answer. (Hint: Let W be the initial wealth of the investor. Express your answer in terms of W.)

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