Question

Company XYZ has a 12-year bond with a face value of $1,000 and an interest rate of 8%. The coupon is paid semiannually. Bonds of similar risk yield a 6% return

1. Compute the bond’s value.

2. Estimate the percentage change in the bond prices if the required return increases to 9 percent and drops to 4 percent.

3. Discuss the relationship you demonstrated in regard to the interest rate risk

4. You found out that the bond is selling on the market for $1,100.

Compute the bond’s yield to maturity and recommend if you should purchase this bond.

5. Assume that the bond matures in 5 years instead of 12 years, recalculate your answers in parts a and b.

6. Explain the implications of your answers in part e, as they related to interest-rate risk.

Answer 1

3) There is an inverse relationship between the YTM and the price of the bond. When the YTM of the bond increases the price of the bond decreases. When the YTM decreases the bond price increases, this is known as the interest rate sensitivity. The risk of change in the value of the bond is measured by the duration of the bond. In the above question we have used the approximate duration formula.