Today at 9am, you bought bonds issued by the same company, the bonds are named L
ID: 2653190 • Letter: T
Question
Today at 9am, you bought bonds issued by the same company, the bonds are named Long and Short.
Long matures in 25 years, pays 6% semi-annual coupon, and has a face value of $5,000. Long is trading for $4,300
Short matures in 2 years, pays 6% semi-annual coupon, and has a face value of $5,000. Short’s Yield to Maturity is 7%.
Today in the afternoon, because of some “Breaking News”, the Yield on these bonds increase by 3%.You decide to sell both the bonds.
What can you say about the sale price? Did you gain or lose? Compare and contrast the magnitude of the loss (measured in percentage) for both Long and Short. What lessons do you infer from this exercise?
Explanation / Answer
Ans
Lessons
The longer the duration of the bond , the more vlotile the market price of the bond . The bond with longer maturity is riskier as compared to one with shorter maturity.
Workings
Table Explaining the change in sales Price ,Loss,Magnitude of loss Long Short Increase in YTM 3% 3% Exsiting YTM 7.2% 7.0% Revised YTM 10.2% 10.0% Revised Trading Price Semi Annual Coupon Payments 150 150 Annuty Factor for 5.1%( 10.2%/2) for 50 Years 17.98 3.546 PV of Coupo Payments 2,696.62 531.90 Face Value 5000 5000 DF 0.08 0.82 PV of Face Value 415.751862 4097.87909 Total PV 3,112.37 4,629.78 Trading Price After Breaking News 3,112.37 4,629.78 Trading Price before Breaking News 4300 4908.165 Loss(Reduction in Trading Price) 1,187.63 278.39 % loss 1187.63/3112.37 *100 278.38/4629.78*100 38% 6%Related Questions
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