solution

You invest in a 2 year AA rated corporate bond. The bond has a face value of $100 and a coupon rate of 3% (paid annually). The AA corporate yield curve is flat at 4% (this implies a discount rate of 4% for all cash flows). Assume all shifts in the yield curve are parallel and that the distribution of 1 day changes in the rates are ?R_AA ~ N(0, 0.0004) (Note: this means that they have mean zero and a standard deviation of 2%). Use the duration approximation to get the 10 day, 95% VaR for this bond. You should provide the bond price, duration and distribution of bond price changes as a minimum amount of working.

Hint: Remember that if X ~ N(µ, s²), then c*X ~ N( c*µ, c²*s²) when c is a constant number.