Assume that Bond A and Bond B are identical in every way except for the coupon r
ID: 2760672 • Letter: A
Question
Assume that Bond A and Bond B are identical in every way except for the coupon rate (i.e., both bonds have the same par value, maturity, and yield to maturity or required rate of return). Bond A has a 12% coupon rate and Bond B is a zero coupon bond. Both bonds have a yield to maturity of 8% per year. If interest rates increase so that the yield on both issues increases to 10%, what would happen to the price of the bonds? Assume that Bond A and Bond B are identical in every way except for the coupon rate (i.e., both bonds have the same par value, maturity, and yield to maturity or required rate of return). Bond A has a 12% coupon rate and Bond B is a zero coupon bond. Both bonds have a yield to maturity of 8% per year. If interest rates increase so that the yield on both issues increases to 10%, what would happen to the price of the bonds?Explanation / Answer
Bond A : The bond holder gets coupon payment every year or half year and the Face Value(FV) at maturity. The Price of the bond is the discounted value of these two types of cash flows. When the Yield increases from 8% to 10% , the Present Value of the cash flow reduces. So the price of the bond will fall.
Bond B : The bond holder had purchased the bond at a discount of 8% and he will get the Face Value(FV) on maturity. That means the future value of the original investment @8% is the Face Value of the bond. If the Yield increases from 8% to 10% , the future value of the investment will increase. So the price of Bond-B will increase in the market.
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