Both bond A and bond B have 8.8 percent coupons and are priced at par value. Bon

Question

Both bond A and bond B have 8.8 percent coupons and are priced at par value. Bond A has 9 years to maturity, while bond B has 18 years to maturity.

Assume if interest rates suddenly rise by 1.4 percent, what is the percentage change in price of bond A and bond B? (Round your answer to 2 decimal places. Negative answers should be indicated by a minus sign. Omit the "%" sign in your response.)

Assume if interest rates suddenly fall by 1.4 percent instead, what would the percentage change in price of bond A and bond B? (Round your answer to 2 decimal places. Omit the "%" sign in your response.)

Assume if interest rates suddenly rise by 1.4 percent, what is the percentage change in price of bond A and bond B? (Round your answer to 2 decimal places. Negative answers should be indicated by a minus sign. Omit the "%" sign in your response.)

Explanation / Answer

The inverse relationship between interest rates and bond prices seems somewhat illogical, but upon closer examination, it makes sense. An easy way to grasp why bond prices move opposite to interest rates is to consider zero-coupon bonds, which don't pay coupons but derive their value from the difference between the purchase price and the par value paid at maturity. When Market Interest Rates Increase Market interest rates are likely to increase when bond investors believe that inflation will occur. As a result, bond investors will demand to earn higher interest rates. The investors fear that when their bond investment matures, they will be repaid with dollars of significantly less purchasing power. Bond A Bond B Years to Maturity 9 18 Coupon Rate 8.80% 8.80% Price at par at par Let Bond Price taken $ 1000 1000 Let yield taken % 7 Working Note:1 If Interest rate rise by 1.4% BOND A (Price of 9 Year Bond)= 88(Pvifa 8.4%,9 Yrs.) +1000(pvif 8.4%,9 yrs.) = 88(6.144)+1000(0.483) = 1023.672 %Change in price = 2.3 BOND B(Price of 18 Year Bond)= 88(Pvifa 8.4%,18 Yrs.) +1000(pvif 8.4%,18 yrs.) = 88(9.11)+1000(0.234) = 1035.68 %Change in price = 3.568 Note=2 If Interest rate falls by 1.4% Price of 9 Year Bond= 88(Pvifa 7%,9 Yrs.) +1000(pvif 7%,9 yrs.) = 88(6.515)+1000(0.544) = 1117.32 %Change in price = 11.732 Price of 18 Year Bond= 88(Pvifa 7%,18 Yrs.) +1000(pvif 7%,18 yrs.) = 88(10.05)+1000(0.295) = 1179.4 %Change in price = 17.94 Conclusion: So the Bond price is more in case of when the interest rate falls which is inversly related to the bond price.

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