rawford Inc. has two bond issues outstanding, both paying the same annual intere

Question

rawford Inc. has two bond issues outstanding, both paying the same annual interest of $55, called Series A and Series B. Series A has a maturity of 12 years, whereas Series B has a maturity of 1 year.

a. What would the value of each of these bond when the going interest rate is (1) 4 percent, (2) 7 percent, and (3) 10 percent? Assume that there is only one more interest payment to be mad on the Series b bonds.

b. Why does the longer-term (12-year) bond fluctuate more when interest rates change than does the shorter-term (1-year) bond?

Explanation / Answer

a. Value of the Bond:

Value of a Bond is equal to the present value of the future inflows of the bond in the form of coupon payment and maturity value.

Formula to calculate present value of future inflow of coupon payment is = Pmt / i [1 - 1 / (1 + i)^n]

Formula to calculate Present value of maturity value = Maturity value / (1+i)^n

b. Longer term bond fluctuate more because of the period remaining to maturity and the future inflows are all more than the bond with a shorter period. So, when discounting is done changes in price of the longer bond will be more.

4% 7% 10% Maturity Value of Bond A 1,140.78 880.86 693.38 Maturity Value of Bond B 1,014.42 985.98 959.09

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