B16. (Interest-rate risk) PhiladelphiaElectric has many bonds trading on the New

Question

B16. (Interest-rate risk) PhiladelphiaElectric has many bonds trading on the New YorkStock

Exchange. Suppose PhilEl’s bondshave identical coupon rates of 9.125% but that oneissue

matures in 1 year, one in 7 years, andthe third in 15 years. Assume that a couponpayment

was made yesterday.

a. If the yield to maturity for allthree bonds is 8%, what is the fair price of eachbond?

b. Suppose that the yield to maturityfor all of these bonds changed instantaneously to7%.

What is the fair price of each bondnow?

c. Suppose that the yield to maturityfor all of these bonds changed instantaneouslyagain,

this time to 9%. Now what is the fairprice of each bond?

d. Based on the fair prices at thevarious yields to maturity, is interest-rate risk thesame,

higher, or lower for longer- versusshorter-maturity bonds?

Explanation / Answer

x.

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