You have a choice of several bonds. Assume the bonds are identical in all respec
ID: 2634294 • Letter: Y
Question
You have a choice of several bonds. Assume the bonds are identical in all respects except their coupon rate and time to maturity, and all bonds pay interest once per year. Details are below.
Bond
Price
Par
Coupon rate
Time to Maturity
A
$1000
$1000
7%
12
B
$1000
$1000
6%
10
C
$1000
$1000
4%
5
D
$1000
$1000
3%
2
If interest rates immediately rise by 2% for each time to maturity, which bond will fall most in price?
Bond A
Bond B
Bond C
Bond D
Bond
Price
Par
Coupon rate
Time to Maturity
A
$1000
$1000
7%
12
B
$1000
$1000
6%
10
C
$1000
$1000
4%
5
D
$1000
$1000
3%
2
Explanation / Answer
Interest rates and bond prices have an inverse relationship.
The rise in interest rate by 2% will lead to a fall in bond prices.
Price of bond A will fall most as its interest rate is the highest. A rise in interest rate will increase its interest rate to 9% which will increase the dicounting effect considerably.
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