2. Understanding what maturity risk means for bonds is very important. Complete the following table by...

2. Understanding what maturity risk means for bonds is very important. Complete the following table by calculating the new bond prices and then the % price change that results for the two bonds given. For example, in the table if interest rates go up 1% on the short term bond, that means that the YTM would go from 4% to 5%. Then calculate the new price at a YTM of 5% and then calculate the % change in price from today's price of $1,000 to the new price.

Short term bond: Face value of $1,000 with an annual coupon rate of 4% with semi-annual payments, and a maturity in 2 years. Assume that today's YTM on a 2 year bond is 4% so therefore today's price is $1,000.

Long term bond: Face value of $1,000 with an annual coupon rate of 5% with semi-annual payments, and a maturity in 30 years. Assume that today's YTM on a 30 year bond is 5% so therefore today's price is $1,000.

	Interest Rates go down by 2%		Interest Rates go down by 1%		Today's Price	Interest Rates go up by 1%		Interest Rates go up by 2%
	New $ Price	% change from Today	New $ Price	% change from Today		New $ Price	% change from Today	New $ Price	% change from Today
Short Term Bond					$1,000

Long Term Bond					$1,000

Expert Solution

Bond Price is equals to present value of all future cash flows discounted at YTM which means Bond's Price depends upon the YTM rate and Duration of Bond. A Bond with longer duration has high interest risk.

Please refer to below spreadsheet for calculation of Bond Price at different YTM.

Formula reference -

We can see in above table, % change in Price of Bond due to change in YTM of Long-term Bond is much higher than short-term bond. This prove that Bond with longer maturity duration has higher interest risk.

jeff jeffy answered 2 years ago

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