Question

Both Bond Sam and Bond Dave have 6 percent coupons, make semiannual payments, and are priced at par value. Bond Sam has four years to maturity, whereas Bond Dave has 19 years to maturity. a. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Sam and Bond Dave? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) b. If rates were to suddenly fall by 2 percent instead, what would be the percentage change in the price of Bond Sam and Bond Dave?

Answer 1

Answer:

a. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Sam and Bond Dave?

• Bond Sam's price will change by -6.73%
• Bond Dave's price will change by -19.37%

b. If rates were to suddenly fall by 2 percent instead, what would be the percentage change in the price of Bond Sam and Bond Dave?

• Bond Sam's price will change by 7.33%
• Bond Dave's price will change by 26.44%

Explanation:

Bond Sam

• 6% / 2 = 3% semiannual payments
• 4 years to maturity = 8 payments
• present value = future value = 100

using an excel spreadsheet I calculated the new market value (present value) if interest increases by 2% ⇒ 4% semiannual, 7 cash flows of $3, one last cash flow of $103:

• if interest increases by 2%, present value (market value) will decrease to $93.27 ⇒ 6.73% decrease

using an excel spreadsheet I calculated the new market value (present value) if interest decreases by 2% ⇒ 2% semiannual, 7 cash flows of $3, one last cash flow of $103.

• If interest decreases by 2%, present value (market value) will increase to $107.33 ⇒ 7.33% increase

Bond Dave

• 6% / 2 = 3% semiannual payments
• 19 years to maturity = 38 payments
• present value = future value = 100

using an excel spreadsheet I calculated the new market value (present value) if interest increases by 2% ⇒ 4% semiannual, 37 cash flows of $3, one last cash flow of $103:

• if interest increases by 2%, present value (market value) will decrease to $80.63 ⇒ 19.37% decrease

using an excel spreadsheet I calculated the new market value (present value) if interest decreases by 2% ⇒ 2% semiannual, 37 cash flows of $3, one last cash flow of $103.

• If interest decreases by 2%, present value (market value) will increase to $126.44 ⇒ 26.44% increase