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In: Finance

a) Consider Bond C – a 4% coupon bond that has 10 years to maturity. It makes semi-annual payments and has a YTM of 7%

 

a) Consider Bond C – a 4% coupon bond that has 10 years to maturity. It makes semi-annual payments and has a YTM of 7%. If interest rates suddenly drop by 2%, what is the percentage change of the bond? What does this problem tell you about the relationship between interest rate and bond price? b) Consider another bond – Bond D, which is a 10% coupon bond. Similar to Bond C, it has 10 years to maturity. It also makes semi-annual payments and have a YTM of 7%. If interest rates suddenly drop by 2%, what is the percentage change of the bonds? Comparing the percentage change of bond C and bond D, what does this tell you about the interest rate risk of bonds with higher coupon rates?

Solutions

Expert Solution

Part a:

% change in price of bond (increase) = 17.19%. The question tells us that price of bond and yield share an inverse relation. When the yield falls, price of the bond rises and vice-versa is true as well.

b)

% change in price of bond (increase) = 14.55%.Based on our answers, it is evident that bond with higher coupon is less sensitive to the changes in yield to maturity. This implies higher coupon rate would imply lower interest rate risk for the bond.

jeff jeffy answered 2 years ago
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