Question

Two bonds A and B have the same credit rating, the same par value, and the same coupon rate. Bond A has 30 years to maturity and bond B has five (5) years to maturity. Please demonstrate your understanding of interest rates risk by answering the following questions: Discuss which bond will trade at a higher price in the market Discuss what happens to the market price of each bond if the interest rates in the economy go up. Which bond would have a higher percentage price change if interest rates go up? Please substantiate your argument with numerical examples. As a bond investor, if you expect a slowdown in the economy over the next 12 months, what would be your investment strategy? please answer each of the question

Answer 1

According to the given data'

lets assume that

Answer a)

Bond A:

par value==>1000 coupon==>6% and payable annually time==>30 ytm==>8%

Price==>(coupon*(1-((1+i)^-n))/i)+(issue price*(1+i)^-n)

coupon==>6%*1000==>60

n==>30, i==>8%, issue price==>1000, price==>774.84

Bond B:

coupon==>6%*1000==>60

n==>5, i==>8%, issue price==>1000, price==>920.15

Bond B trades at higher price in market

Answer b)

Bond A:

coupon==>6%*1000==>60

n==>5, i==>10%, issue price==>1000, price==>622.92

Bond B:

coupon=6%*1000=60

n=5, i=10%, issue price=1000, price=848.37

Both the bonds price will come down

Answer c)

Percentage change==>(final/initial)-1

Bond A==>(622.92/774.84)-1==>-19.61%

Bond B==>(848.37/920.15)-1==>-7.80%

highest percentage change is for Bond A

Answer d)

As a bond investor, my investment strategy will be Sell Bond B and hold Bond A

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