8. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has

Question

8.

You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?

a. The prices of both bonds will increase by 7% per year. b. The price of Bond B will decrease over time, but the price of Bond A will increase over time. c. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate. d. The prices of both bonds will remain unchanged. e. The price of Bond A will decrease over time, but the price of Bond B will increase over time.

Explanation / Answer

b.     The price of Bond A will decrease over time, but the price of Bond B will increase over time.

Suppose Face value of bond = 100, life = 3years

In first case,

Price of bond = 9x2.624 + 100 x .816 = 105.216

2nd case, Price of bond = 6 x 2.624 +100x.816 = 97.344

Price of Bond B is less

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