Question

Bond Relationships. Select one or more of the following phrases to complete the following sentences. increase, decrease, par, discount, premium, less than, more than, greater , less

a. If the current interest rate exceeds the bond’s coupon rate, the bond will sell at a

___________.

b. The value of a bond to increase if there is a/an ________ in interest rates.

c. A bond’s coupon rate is more than the interest rate, therefore the bond is selling at a

_____________.

d. As interest rate increases the value of a bond will ______________.

e. If the bondholder’s required rate of return equals the coupon interest rate, the bond will sell at _________.

f. A premium bond sells for ____________ as maturity approaches.

g. The discount bond sells for ____________ as maturity approaches.

h. A bondholder with a short-term bond is exposed to ___________ interest rate risk than when owing a long-term bond.

Answer 1

(a) If the current interest rate exceeds the bond's coupon rate, than the bond will sell at a discount.

(b) The value of a bond to increase if there is a decrease in interest rates.

(c) A bond's coupon rate is more than the interest rate, therefore the bond is selling at a premium.

(d) As interest rate increases, the value of a bond will decrease. This is because the fixed interest and principal payments stated in the bond will become less attractive to investors because investors can earn more with increased interest rates with the same amount of money. So bond will have to be cheaper in order to attract them.

(e) If the required rate of return equals the coupon interest rate, the bond will sell at par.

(f) The premium bond sells for less as maturity approaches. Because bond sold at maturity at premium has the premium amortized over the term of the bond to reduce the value of the bond to its par value at maturity.The price moves toward face value as maturity approaches. Current price of the bond is higher because of premium, it reduces till it reaches its face value at maturity

(g) The discount bond sells for greater as maturity approaches, because currently bond is sold at discount which is less than its face value, and it reaches its face value as maturity approaches.

(h)   A bondholder with a short term bond is exposed to less interest rate risk when owning a long term bond because

in case of long term bonds if interest rate rises (which normally happens in long term), it will affect bond's market price (price reduces, as interest rise) and when the investors sell their bonds early they may end up by selling them at deep discounts. While in short term bonds, interest rates are less likely to change.