Question

An investor has two bonds in his portfolio that both have a face value of $1,000 and pay a 8% annual coupon. Bond L matures in 14 years, while Bond S matures in 1 year.

Assume that only one more interest payment is to be made on Bond S at its maturity and that 14 more payments are to be made on Bond L.

1. What will the value of the Bond L be if the going interest rate is 5%? Round your answer to the nearest cent.
   $   
   
   What will the value of the Bond S be if the going interest rate is 5%? Round your answer to the nearest cent.
   $   
   
   What will the value of the Bond L be if the going interest rate is 8%? Round your answer to the nearest cent.
   $   
   
   What will the value of the Bond S be if the going interest rate is 8%? Round your answer to the nearest cent.
   $   
   
   What will the value of the Bond L be if the going interest rate is 12%? Round your answer to the nearest cent.
   $   
   
   What will the value of the Bond S be if the going interest rate is 12%? Round your answer to the nearest cent.
   $   
   
2. Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?
   
   1. Long-term bonds have greater interest rate risk then do short-term bonds.
   2. The change in price due to a change in the required rate of return decreases as a bond's maturity increases.
   3. Long-term bonds have lower interest rate risk then do short-term bonds.
   4. Long-term bonds have lower reinvestment rate risk then do short-term bonds.
   5. The change in price due to a change in the required rate of return increases as a bond's maturity decreases.

Answer 1

What will the value of the Bond L be if the going interest rate is 5%? Round your answer to the nearest cent.
$

	Particulars	Interest	Principal	Bond price
a	Each payment	80	1000
	Number of payments	14	1
b	Present value factor @5%	$ 9.89864	$ 0.50507
c= aXb	Present value	$ 791.89	$ 505.07	$ 1,296.96

What will the value of the Bond S be if the going interest rate is 5%? Round your answer to the nearest cent.
$

	Particulars	Interest	Principal	Bond price
a	Each payment	80	1000
	Number of payments	1	1
b	Present value factor @5%	$ 0.95238	$ 0.95238
c= aXb	Present value	$ 76.19	$ 952.38	$ 1,028.57

at 8% rate bond price equals their face value as it is stated rate of interest. Bond price is $1,000 for both L and S

at 12% bond L price:

	Particulars	Interest	Principal	Bond price
a	Each payment	80	1000
	Number of payments	14	1
b	Present value factor @1%	$ 6.62817	$ 0.20462
c= aXb	Present value	$ 530.25	$ 204.62	$ 734.87

at 12% bond S price:

	Particulars	Interest	Principal	Bond price
a	Each payment	80	1000
	Number of payments	1	1
b	Present value factor @1%	$ 0.89286	$ 0.89286
c= aXb	Present value	$ 71.43	$ 892.86	$ 964.29

Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?

correct option is

1. Long-term bonds have greater interest rate risk then do short-term bonds.