you own a bond that pays $100 in annual interest, with a $1,000 par value. it ma

Question

you own a bond that pays $100 in annual interest, with a $1,000 par value. it matures in 15 years. the market's required yield to maturity on a comparable-risk bond is 11 percent.

a. Calculate the value of the bond.

b. How does the value change if the yield to maturity on a comparable-risk bond (i) increases to 16

percent or (ii) decreases to 6 percent?

c.Explain the implications of your answers in part b as they relate to interest-rate risk, premium bonds, and discount bonds.

d.Assume that the bond matures in 5 years instead of 15 years and recalculate your answers in parts a and b.

e.Explain the implications of your answers in part d as they relate to interest-rate risk, premium bonds, and discount bonds.

Explanation / Answer

a)

Bond value = PV(11%,15,-100,-1000) = 928.09

b)

YTM = 16%

Bond value = PV(16%,15,-100,-1000) = 665.47

YTM = 6%

Bond value = PV(6%,15,-100,-1000) = 1388.49

c)

Bond prices are inversely related with Yields (Interest rates).

Bond price will be lower than face value if required return increase and higher if required returns decrease.

d)

YTM = 16%, Maturity = 5

Bond value = PV(16%,5,-100,-1000) = 803.54

YTM = 6%, Maturity = 5

Bond value = PV(6%,5,-100,-1000) = 1168.49

e)

Higher the maturity date, bonds will get more exposure to interest rate risk. If maturity date reduces, the bond price will become stable and less fluctuation. If the required return increased, bond will sell at greater discount off the face value, and vice versa.

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