Question

Information on four bonds is presented in the table. Each bond has a face value of $100. Each bond that pays a coupon pays it annually.

BOND	MATURITY (YEARS)	COUPON RATE	YTM
A	1	0%	5%
B	5	6%	7%
C	10	10%	9%
D	20	0%	8%

a) Compute the percentage change in the price of each bond assuming its yield to maturity (YTM) increases by 1%, for example, from 5% to 6%.

b) If you think that bond yields generally will decrease in the next 3 months, which bond would you prefer to own now? Briefly explain.

Answer 1

Answer (a):

We calculate current price using excel formula PV:

Price of Bond A = PV (rate, nper, pmt, fv, type) = PV (5%, 1, 0, -100,0) = $95.24

When YTM increases by 1%:

Price of Bond A = PV (6%, 1, 0, -100,0) = $94.34

% change in price = (94.34 - 95.24) / 95.24 = - 0.94%

Similarly we calculate the current price, Price on 1% increase of YTM and % change in price as below:

The above excel with 'show formula' is as follows:

Answer (b):

I would prefer to own Bond D

As we observe in table in answer a above, on 1% change in YTM, maximum price change occurs in Bond D.

When yield is expected to decrease bond price will rise. As the maximum % change occurs in Bond D