Suppose that Bond B is selling at par. You learn that ifinterest rates rise by...

Suppose that Bond B is selling at par. You learn that if interest rates rise by 5% Bond B’s price will fall to 97 per 100 of par. What will happen if interest rates fall by 5%?

Expert Solution

We need the duration and convexity of the bond to solve the problem accurately.

Approximately speaking, the fall in bond price due to the rise in interest rate is smaller than the rise in bond price due to the fall in interest rate, due to the convexity effect.

Here the fall in Bond price due to the rise in interest rate by 5% was from 100 to 97, so $3.

So when the interest rate falls by 5%, then the bond price will rise by more than $3, so the bond price will cross $103.

jeff jeffy answered 2 years ago

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