Bond A has the following: 20 years left to maturity 7.5% Coupon Rate Semiannual payments Bond...

Bond A has the following:
20 years left to maturity
7.5% Coupon Rate
Semiannual payments

Bond B has the following:
5 years left till maturity
7.5% Coupon Rate
Semiannual payments

Both bonds are similar to each other in all other features and risk. If the current market rate of interest suddenly drops from 7% to 5%, which of these bonds will change more in value? Please show calculations of each bond valuation at 7% as well as 5% and compute percentage change in price to arrive at your answer. Also include a short paragraph explaining two kinds of interest rate risk.

Thank you very much!

Solutions

Expert Solution

It is seen from above that Bond A changes more in value than Bond B for a given change in interest rate. This is due to a measure called Convexity. The convexity is the change in price for a given change interest rate and it is higher for longer duration bonds.

The two kinds on interest rate risk are Price risk and Reinvestment risk. Price risk is the change in Price of a bond which can change the underlying change in interest rates. A change in interest rate can also lead to non availability of opportunity to reinvest with the current investment rate.

Formulae

Formulae as above...

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Bond X is a premium bond making semiannual payments. The bond has a coupon rate of 7.5 percent, a YTM of 6 percent, and 13 years to maturity.

Bond X is a premium bond making semiannual payments. The bond has a coupon rate of 7.5 percent, a YTM of 6 percent, and 13 years to maturity. Bond Y is a discount bond making semiannual payments. This bond has a coupon rate of 6 percent, a YTM of 7.5 percent, and also 13 years to maturity. Assume the interest rates remain unchanged and a $1,000 par value. a. What are the prices of these bonds today? (Do not round intermediate...

A bond has a coupon rate of 8 percent, 7 years to maturity, semiannual interest payments,...

A bond has a coupon rate of 8 percent, 7 years to maturity, semiannual interest payments, and a YTM of 7 percent. If interest rates suddenly rise by 1.5 percent, what will be the percentage change in the bond price?

A bond has a coupon rate of 8 percent, 7 years to maturity, semiannual interest payments,...

A bond has a coupon rate of 6 percent, 9 years to maturity, semiannual interest payments,...

A bond has a coupon rate of 6 percent, 9 years to maturity, semiannual interest payments, and a YTM of 8 percent. If interest rates suddenly rise by 2 percent, what will be the percentage change in the bond price? Group of answer choices -13.9 percent +14.0 percent -12.3 percent -14.0 percent -11.4 percent

Consider a bond that has a coupon rate of 7.5%, five years to maturity, and is...

Consider a bond that has a coupon rate of 7.5%, five years to maturity, and is currently priced to yield 7.5%. Calculate the following:  Macaulay duration  Modified duration  Percentage change in price for a 1% increase in the yield to maturity

A 20-year fixed coupon bond has 12 years left until maturity. It has a 7% coupon rate...

A 20-year fixed coupon bond has 12 years left until maturity. It has a 7% coupon rate paid SEMI-ANNUALLY. If the price of the bond is $850, what is the annual yield? a. 9.08% b. 4.56% c. 9.11% d.4.54% e. 8.60%

Jiminy’s Cricket Farm issued a bond with 20 years to maturity and a semiannual coupon rate...

Jiminy’s Cricket Farm issued a bond with 20 years to maturity and a semiannual coupon rate of 5 percent 2 years ago. The bond currently sells for 96 percent of its face value. The company’s tax rate is 21 percent. The book value of the debt issue is $55 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 8 years left to maturity; the book value of this issue is $30...

A bond outstanding with 10 years to maturity, an 9.25% nominal coupon, semiannual payments, and a...

A bond outstanding with 10 years to maturity, an 9.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 4.5 years at a price of $1,100. What is the bond's nominal yield to call?

Consider a bond with semiannual payments with 10 years to maturity, coupon of 10%, 8% as...

Consider a bond with semiannual payments with 10 years to maturity, coupon of 10%, 8% as Yield to Maturity (YTM),and face value of 1000, a. Find the price of the bond at t=0. b. Interest rates drop by 1% after 1 year. Find the new Price of the bond. c. Interest rates drop to 0% after two years from time 0. Find the new price. d. Interest rates turn negative to -5% after 3 years from t= 0. Find the new...

What is the market value of a bond with 20 years left to maturity, a coupon...

What is the market value of a bond with 20 years left to maturity, a coupon payment of $35 every 6 months, and a $1,000 face value if the yield to maturity is 5%?

Subjects