Question

An investor has two bonds in his portfolio that have a face value of $1,000 and pay an 8% annual coupon. Bond L matures in 14 years, while Bond S matures in 1 year.

1. What will the value of the Bond L be if the going interest rate is 5%, 6%, and 9%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 14 more payments are to be made on Bond L. Round your answers to the nearest cent.

   	5%	6%	9%
   Bond L	$	$	$
   Bond S	$	$	$

2. Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?
   1. The change in price due to a change in the required rate of return decreases as a bond's maturity increases.
   2. Long-term bonds have lower interest rate risk than do short-term bonds.
   3. Long-term bonds have lower reinvestment rate risk than do short-term bonds.
   4. The change in price due to a change in the required rate of return increases as a bond's maturity decreases.
   5. Long-term bonds have greater interest rate risk than do short-term bonds.

Answer 1

Calc:

Bonds with the lowest coupon rate and highest years to maturity are more sensitive to changes in yield, whereas bonds with least years to maturity plus highest bond coupon rates are least sensitive.