Question

Assume that there is a flat yield curve where the current interest rate on all government bonds is 10% per annum. The government has just issued 1-year, 2-year, 5-year and 10-year bonds, all offering an interest rate of 10%, a face value of $100 and paying interest once per annum. Calculate the market price for each of these bonds, assuming that immediately following purchase of the bonds at $100 there is either a parallel upward movement in the yield curve to 12 percent per annum or a parallel downward movement in the yield curve to 8 percent per annum. Explain the effect on interest rate change on bond prices taking into consideration the different maturities.

Answer 1

Formuals Used:-

Maturity	Price at 10%	Price at 12%	Price at 8%
1	=PV(10%,$B3,-10,-100)	=PV(12%,$B3,-10,-100)	=PV(8%,$B3,-10,-100)
2	=PV(10%,$B4,-10,-100)	=PV(12%,$B4,-10,-100)	=PV(8%,$B4,-10,-100)
5	=PV(10%,$B5,-10,-100)	=PV(12%,$B5,-10,-100)	=PV(8%,$B5,-10,-100)
10	=PV(10%,$B6,-10,-100)	=PV(12%,$B6,-10,-100)	=PV(8%,$B6,-10,-100)

as we can see in above table that, if the interest rate in the market increase the price of the bond will reduce because in market other securities are providing higher return than our own securities. while at other side when the interest rate in market decrease price of the bond will increase because our bond will be paying higher rate than the rate prevailing in the market hence the price of the Bond will increase because investor will like to nuy this bond and as the maturity is higher the higher the bond is sensible to the interest rate in the market.