xxx has two bonds issue outstanding , both paying the same annual interest of $5
ID: 2445758 • Letter: X
Question
xxx has two bonds issue outstanding , both paying the same annual interest of $55, called series A and series B. Series A has a maturity of 12 years, whereas Series B has a maturity of 1 year.
a. What would be the value of each of these bonds when the going interest rate is (1) 4percent, (2) 7 percent, and (3) 10 percent? assume there is only one more interest payment to be made on the series B bonds.
b. Why does the longer term (12 years) bond fluctuated more when the interest rate change than does the shorter term (1 year) bond?
Explanation / Answer
Let us find the value of each of the bond using the discounting cash flow method at each of the three different rates
A).
Series A Bonds
Series B Bonds
B). The longer term bond fluctuates more because of compounding. The cash flows are discounted based on compounding interest rates and therefore the compounding effect impacts significantly the value of the bond. Higher the interest rate lower is the value.
Assumed $1000 FV Year Particulars Cash Flow 4% Amount(In $) 7% Amount(In $) 10% Amount(In $) 1 Interest 55 0.9615 52.88 0.9346 51.40 0.9091 50.00 2 Interest 55 0.9246 50.85 0.8734 48.04 0.8264 45.45 3 Interest 55 0.8890 48.89 0.8163 44.90 0.7513 41.32 4 Interest 55 0.8548 47.01 0.7629 41.96 0.6830 37.57 5 Interest 55 0.8219 45.21 0.7130 39.21 0.6209 34.15 6 Interest 55 0.7903 43.47 0.6663 36.65 0.5645 31.05 7 Interest 55 0.7599 41.80 0.6227 34.25 0.5132 28.22 8 Interest 55 0.7307 40.19 0.5820 32.01 0.4665 25.66 9 Interest 55 0.7026 38.64 0.5439 29.92 0.4241 23.33 10 Interest 55 0.6756 37.16 0.5083 27.96 0.3855 21.20 11 Interest 55 0.6496 35.73 0.4751 26.13 0.3505 19.28 12 Interest 55 0.6246 34.35 0.4440 24.42 0.3186 17.52 12 Principal 1000 0.6246 624.60 0.4440 444.01 0.3186 318.63 1,140.78 880.86 693.38Related Questions
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