Assume that today you purchased a Treasury Note with the following characteristics: Par (face) value =...

Assume that today you purchased a Treasury Note with the following characteristics: Par (face) value = $1,000 Maturity = five years from today Coupon interest rate =5%

ALL OTHER THINGS BEING EQUAL:

If the prevailing interest rates for instruments of similar risk and maturity were to increase from 5% to 10% next week, what would happen to the value of your bond in the secondary market? Explain. (It is not necessary to calculate the yield to maturity. Simply explain the general effects of the change in rates)

Solutions

Expert Solution

Yield to Maturity is interest rate prevailing in market. It is technically the rate we would earn if bond is kept till maturity (assuming reinvestment rate is same as yield to maturity).

Interest rate and price of bond have inverse relationship.

When interest rate falls, price of bond rises and when interest rate rises, price of bond falls.

It is because when the interest rate in market rises, market expectation from bond increases. However bond terms remains same (have same coupon and same maturity date). So the value of same bond is less for the investor since investors' expected rate (market rate) has rised.

In above case, when yield = 5% which is equal to coupon, pirce of bond will be equal to it's face value. That is $1000.

So, when yield to maturity rises from 5% to 10%, price of bond will fall below $1000.

Thumbs up please if satisfied from above explaination. Thanks :)

Comment for further doubts.

jeff jeffy answered 1 year ago

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