Question
In: Finance
Consider a five-year bond with a 10% coupon selling at a yield to maturity of 8%....
Consider a five-year bond with a 10% coupon selling at a yield to maturity of 8%. If interest rates remain constant, one year from now the price of this bond will be:
A. Higher
B. Lower
C. The same
D. Par
Solutions
Expert Solution
The correct answer is Option B(Lower).
Here is why
The coupon rate of this bond is 10% and Yield To maturity is 8%. Clearly, Coupon Rate > Yield to Maturity
That is why this bond will be selling at a premium. But If
interest rates remain constant, one year from now the price of the
bond will be lower due to the fact that
Bond Price approaches its par value as the time to maturity
approaches its maturity date. We can understand this with help of
an example. Let's say a bond has a par value of $1000 and a coupon
rate of 8% and YTM is 6%, we shall be calculating the bond price in
two cases; first when the bond has a life of 10 years and secondly
when bond has a life of 5 years. Let's calculate the bond
price:
As we can see the bond value
has reduced from $1147.20 to $1084.25 when time period changed from
10 to 5 years, that is the bond has started approaching the par
value. Its price is lower now.
jeff jeffy answered 2 years agoRelated Solutions
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