Question

Suppose a 10-year zero coupon Treasury bond with a face value of $10, 000 sells for $6,000.

a. Find the bond value.

b. Suppose the price of the above bond rose to Kshs 7,500, find the new yield.

c. Explain what happens when interest rates increase.

Answer 1

a). P = 10,000/(1+r)¹⁰

6000 = 10,000/(1+r)¹⁰

this gives a yield of 

r = 5.24%

b). P = 10,000/(1+r)¹⁰

7500 = 10,000/(1+r)¹⁰

this gives a yield of 

r = 2.92%

c). When interest rates increase, all else equal, existing bond yields become less attractive, thus the demand for (and the price of) bonds falls, resulting in yields rising until bonds are attractive to buyers again.

The higher the price of the bond the lower the yield.