an investor has two bonds in his portfolio that have a face value of $ 1,000 and
ID: 2790771 • Letter: A
Question
an investor has two bonds in his portfolio that have a face value of $ 1,000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year. a. What will the value of each bond be if the going interest rate is 5%, 8%, and 12%? assume that only one more interest payment is to be made on bond s at its maturity and that 15 more payment are to be made on bond L. B why does the longer- term bond price vary more than the price of the shorten- term bond when interest rate change?
Explanation / Answer
@5%: Price of Bond L=100/1.05+100/1.05^2+............100/1.05^15+1000/1.05^15=$1518.983
@8%: Price of Bond L=100/1.08+100/1.08^2+............100/1.08^15+1000/1.08^15=$1171.19
@12%: Price of Bond L=100/1.12+100/1.12^2+............100/1.12^15+1000/1.12^15=$863.7827
@5%: Price of Bond S=1100/1.05=$1047.619
@8%: Price of Bond L=1100/1.08=$1018.519
@12%: Price of Bond L=1100/1.12=$982.1429
Longer term has more interest rate risk because of higher duration and hence its price varies more than the short term bond's price
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