Question

1.Suppose that the interest rates paid on corporate bonds are currently 8%, but you expect them to fall moderately in the near future. If your expectation is correct, buying bonds today would be wise because:

(a)lower rates make bonds less risky.

(b)stocks are a bad investment because their prices are likely to fall when rates fall.

(c)falling rates will make the market value of the 8% bonds rise, giving you the potential to profit from capital gains.

(d)these bonds are unaffected by interest rates.

Answer 1

(c)falling rates will make the market value of the 8% bonds rise, giving you the potential to profit from capital gains.

The price of the bond and the interest rates are inversely related to the decrease in the rate will increase the price so the difference in the prices will be the capital gain

ex.

suppose the face value of the zero-coupon bond is 100 and the maturity is in 10 years

at 8%

price=100*(1.08^-10)

=46.3193488

=46

and the interest rate of 3% then

price =100*(1.03^-10)

=74.4093915

=74

the gain=74-46=28