Question

The Falcon Corp. has a 6 percent coupon bond outstanding. The Sonata Company has a 14 percent bond outstanding. Both bonds have 12 years to maturity, make semi-annual payments, and have a YTM of 10 percent
1- Calculate the price of each bond
2- If interest rates suddenly rise by 2 percent, what is the percentage change in the price of these bonds?
3- Show by calculations, which one has higher interest rate risk

Answer 1

	CURRENT PRICE OF THE BONDS:
	Price of a bond, is the sum of the PV of the maturity
	value of the bond and the PV of periodic interest payments
	when discounted at the YTM.
1]	Price of Falcon bond = 1000/1.05^24+30*(1.05^24-1)/(0.05*1.05^24) =	$            724.03
	Price of Sonata Bond = 1000/1.05^24+70*(1.05^24-1)/(0.05*1.05^24) =	$ 1,275.97
2]	Price at 12% YTM:
	Price of Falcon bond = 1000/1.06^24+30*(1.06^24-1)/(0.06*1.06^24) =	$            623.49
	Price of Sonata Bond = 1000/1.06^24+70*(1.06^24-1)/(0.06*1.06^24) =	$ 1,125.50
	% Change in price:
	Falcon bond = 623.49/724.03-1 =	-13.89%
	Sonata bond = 1125.50/1275.97-1 =	-11.79%
3]	Maturities remaining the same, the bond with lower
	coupon rate his higher risk, as is evidenced by the
	% change in price of the bonds for a given change in
	market interest rate.