Question

Q. You believe interest rates will soon fall.

a. Would you rather own a three-year, 6 percent coupon, fixed-rate bond or an equivalent-risk, three-year, floating-rate bond currently paying 6 percent interest?

b. Would your answer to (a) change if you were contemplating issuing a bond rather than owning one? If so, how?

c. Would your answer to (a) change if, as an investor, you believed interest rates would soon rise? If so, why?

d. In the current market scenario with low interest rate if you are planning to buy a new house in next 60 days would you prefer a fixed rate mortgage or variable rate mortgage? Explain?

Answer 1

ans....
a. I would rather own a fixed-rate bond because the interest income I receive from a floating-rate bond will fall as interest rates decline. Equivalently, the market value of the fixed-rate bond will rise as rates fall, but that of the floating-rate bond will not. (This presumes the fixed-rate bond is not callable.)
b. I would rather issue a floating-rate bond now because future interest payments will fall as rates decline.
c. As an investor, I would want to hold a floating-rate bond because interest income will rise as interest rates rise. Equivalently, the price of the fixed-income bond will fall as rates rise, while that of the floating-rate bond will not.
Source: http://byuibc.org/files/BM402-18%20Chapter%205%20Additional%20Problems%202010-10-28.doc