LLK Ltd recently issued bonds paying a fixed annual coupon of 10% p.a. and maturing in...

LLK Ltd recently issued bonds paying a fixed annual coupon of 10% p.a. and maturing in 5 years’ time. The yield to maturity on these bonds is 8% p.a. If market interest rates fall, what is most likely to happen to the price of the bonds?

Expert Solution

Lets assume the bond value = $1000

Annual coupon @ 10% =10% =$100

Yield to maturity =8% p.a

Value of the bond =100*PVAF(8%,5 years) + 1000*PVF(8%, 5th year)

=100*3.993 + 1000*0.6806

=1079.9 = 1080

If market interest rate has fallen, suppose assume 7% as market interest rate

Value of the bond =100*PVAF(7%,5years) + 1000*PVF(7%, 5th year)

=100* 4.102 + 1000*0.7129

=1123.1 = 1123

Bond value has been increased , when market interest rate has fallen.

There is an inverse relationship between Market interest rate and bond value.

If interest rates decline, bond prices will rise.

A rise in demand will push the market price of the bonds higher and bondholders might be able to sell their bonds for a price higher than their face value of $1000.

jeff jeffy answered 2 years ago

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