Question

Both Bond C and Bond D have 8 percent coupons, make semiannual payments, and are priced at par value. Bond C has 3 years to maturity, whereas Bond D has 20 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond C? Of Bond D? If rates were to suddenly fall by 2 percent instead, what would the percentage change in the price of Bond C be then? Of Bond D? Illustrate your answers by graphing bond prices versus YTM. What does this problem tell you about the interest rate risk of longer-term bonds?

Answer 1

I have Attached screenshots of Excel sheets in which the solution and graph is given.

From the graph, it can be found that Long term bonds are more sensitive to Interest rate changes.There is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within a longer time period than within a shorter period. As a result, investors who buy long-term bonds but then attempt to sell them before maturity may be faced with a deeply discounted market price when they want to sell their bonds.