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Solve the problem in EXCEL You are considering issuing two types of bonds. The current yield...

Solve the problem in EXCEL

You are considering issuing two types of bonds. The current yield to maturity on similar bonds is 4% annually. Both bonds have a face value of $1000 and will pay annual coupons. Bond A has a maturity of 10 years and bond B has a maturity of 20 years. You want to compute the price of both bonds at the prevailing interest rate and see what happens to the price of the bonds as the interest rate changes. You should consider a range of interest rates starting in 2 % and ending in 7%, with increments of 0.1%. Calculate the price of both bonds at each interest rate and plot the bond prices against the interest rate. What do your results indicate about the interest rate risk of bonds with longer time to maturity?

Solutions

Expert Solution

Price of a bond is the present value of its cash flows. The cash flows are the coupon payments and the face value receivable on maturity

Price of bond is calculated using PV function in Excel :

rate = (YTM of bond = market interest rate)

nper (Years remaining until maturity)

pmt = (annual coupon payment = face value * coupon rate)

fv = (face value receivable on maturity)

As the bonds are being issued today, their coupon rate will equal the YTM of 4%.

The prices of each bond at various interest rates are calculated below :

The plot is below :

The result indicates that bonds with longer maturity have higher interest rate risk.

This is because for an equal change in interest rate, the change in the price of Bond B is higher

jeff jeffy answered 1 year ago
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