John owns a corporate bond with a coupon rate of 8% that matures in 10 years. Bi

Question

John owns a corporate bond with a coupon rate of 8% that matures in 10 years. Bill owns a corporate bond with a coupon rate of 12% that matures in 25 years. If interest rates go down, then:

A.the value of John's bond will decrease and the value of Bill's bond will increase.

B.the value of both bonds will increase.

C.the value of Bill's bond will decrease more than the value of John's bond due to the longer time to maturity.

D.the value of both bonds will remain the same because they were both purchased in an earlier time period before the interest rate changed.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Option B (the value of both bonds will increase) is the correct answer.

Explanation:

There is an inverse relationship between the price of bonds and interest rate. If interest rates increase, the value of bonds go down and if interest rates fall, the value of bonds increases. In case of both the bonds owned by John, he would continue to receive fixed interest payments which will be higher than the interest amount available on new bonds which are issued at lower interest rates. Therefore, the value of both of these bonds would increase.

Thanks.

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