Question

It is a myth that bonds are always less risky than stocks. Bond investors can really lose their shirts (go broke) in a rising interest rate environment. Suppose you buy a 12-year bond with a face value of $10,000 and a coupon rate of 2%. Interest rates unexpectedly double over the next 12 months. You become discouraged and cash out. How much will you be able to raise by selling the bond

Answer 1

Answer:

$8247.90 will be generated on the bond after 12 months

Explanation:

It will take a $10000 bond 12 years to be full matured.

at interest rate 2%,

coupon value will be 0.02*10000 = $200

if 2% doubles in 12 months, new interest rate will be

0.02*2 = 0.04

To get the amount raised after at 12 month cashout, excel can be used with the parameters below

-PV(0.04,12-1,200,10000)

= $8247.90