of $1,000. Each pay 6 years. If the 6) Consider two bonds, A and B. Both bonds p

Question

of $1,000. Each pay 6 years. If the 6) Consider two bonds, A and B. Both bonds presently are selling at their par value interest of $120 annually. Bond A will mature in 5 years while bond B will mature in yields to maturity on the two bonds change from 12% to 14% a) b) c) d) both bonds will increase in value but bond A will increase more than bond B both bonds will increase in value but bond B will increase more than bond A both bonds will decrease in value but bond A will decrease more than bond B both bonds will decrease in value but bond B will decrease more than bond A

Explanation / Answer

The interest rates and prices of bonds have a inverse relationship. Therefore, when interest rates increase from 12% to 14%, the prices of bonds would decrease. Also, the longer the maturity of a bond, the more sensitive is its price to a change in interest rates. In our case, Bond B has a longer maturity than Bond A. Concluding, both bonds will decrease in value as interest rates increase but bond B will decrease more than bond A as it has more number of years to maturity. (option d)

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