A) Diane Carter is interested in buying a five-year zero coupon bond with a face

Question

A) Diane Carter is interested in buying a five-year zero coupon bond with a face value of $1,000. She understands that the market interest rate for similar investments is 7.41 percent. Assume annual coupon payments. What is the current value of this bond?

B) Which one of the following statements is NOT true?

1.Yield curves show graphically how market yields vary as term to maturity changes.

2The relationship between yield to maturity and marketability is known as the term structure of interest rates.

3.The shape of the yield curve is not constant over time.

4.As the general level of interest rises and falls over time, the yield curve shifts up and down and has different slopes.

C)Which of the following statements is true?

1. If market interest rates rise, a 10-year bond will fall in value more than a 1-year bond.

2.For a given change in market interest rates, the prices of higher-coupon bonds change more than the prices of lower-coupon bonds.

3. If market interest rates rise, a 1-year bond will fall in value more than a 10-year bond.

4. If interest rates rise, bond prices will rise.

Explanation / Answer

Solution:-

A) Ans:- Current price= $699.48

Calculation current value of zero coupon bond

Price of bond= Maturity value / (1+required rate of return)years

                        =$1,000/(1+0.0741)5

                        =$699.48

B) Ans:- 2)The relationship between yield to maturity and marketability is known as the term structure of interest rates.

Explanations:-

1)Yield is the graphical representation , and yield curve is not constant and yield curve shifts up and down had different slopes these are correct as they are the characteristics of yield curve.

2)Term structure of interest rate means relationship between bond yield and maturity not the given relationship.

c) Ans:- 1) If market interest rates rise, a 10-year bond will fall in value more than a 1-year bond.

Explanation:-

1) The 10 year bond will fall in value more due to higher discount rate , whose present value will be lower.

2) This is not correct

3) 10 year bond will decrease more than 1 year bond

4) If interest rate rise , bond prices fall

Please feel free to ask if you have any query in the comment section.

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