Question

​(Bond relationship​) ​Mason, Inc. has two bond issues​ outstanding, called Series A and B, both paying the same annual interest of ​$105. Series A has a maturity of 12 ​years, whereas Series B has a maturity of 1 year.

a. What would be the value of each of these bonds when the going interest rate is​ (1) 7 ​percent, (2) 11 ​percent, and​ (3) 13 ​percent? Assume that there is only one more interest payment to be made on the Series B bonds.

b. Why does the​ longer-term ​(12​-year) bond fluctuate more when interest rates change than does the​ shorter-term ​(1​-year) ​bond?

When the going interest rate is 7 ​percent, the value of Series A bonds would be?

​

Answer 1

The price of the bonds have to be found using PV function in EXCEL

=PV(rate,nper,pmt,fv,type)

Series A Bonds:

a. rate=interest rate=7%

nper=maturity time=12

pmt=$105

fv=$1000

type=0

=PV(7%,12,105,1000,0)=$1,277.99

b. if interest rate becomes=11%, rate=11% and all other numbers remain same

=PV(11%,12,105,1000,0)=$967.54

c. if interest rate becomes=13%, rate=13% and all other numbers remain same

=PV(13%,12,105,1000,0)=$852.06

Series B Bonds:

Series B bonds have only 1 year maturity

a. rate=7%

nper=1

pmt=105

fv=1000

=PV(7%,1,105,1000,0)=$1032.71

b. If interest rates=11%, rate=11% and else will be same

=PV(11%,1,105,1000,0)=$995.50

c. If interest rates=13%, rate=13% and else will be same

=PV(13%,1,105,1000,0)=$977.88

2. The interest rates fluctuate more for the higher maturity bonds rather than the less maturity bonds due to risk involved in holding the bonds. Over the period of the time, the interest rate fluctuates more with the higher maturity bonds but with 1 year Series B bond the interest rate risk is less, hence the bond fluctuates less. Due to this reason, long term bond (series A bond fluctuates more with changes in interest rates)