7-5 (Bond Valuation) Crawford Inc. has two bond issues outstanding, both paying
ID: 2779257 • Letter: 7
Question
7-5 (Bond Valuation) Crawford Inc. has two bond issues outstanding, both paying the same annual interest of $85, 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 be the value of each of these bonds when the going interest rate is (1) 5 percent, (2) 8 percent, and (3) 12 percent? Assume there is only one more interest payment to be made on the Series B bonds.
b)Why does the longer-term (12-year) bond fluctuate more when interest rates change than deos the shorter-term (1-year) bond?
Explanation / Answer
a. Series A:
Value (Vb) =
Value (Vb) =
Value (Vb) =
12
= 5% 8% 12%
85
1000
®ANSWER 1,310.21 1,037.68 783.20
Series B
Value (Vb) =
Value (Vb) =
Value (Vb) =
1
= 5% 8% 12%
85
1000
®ANSWER 1,033.33 1,004.63 968.75
b. Longer-term bondholders are locked into a particular interest rate for a longer period of time and are therefore exposed to more interest rate risk
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