Question

- Historically, governments might want to reduce interest rates on consols and would then convert them into new consols with the lower interest rate. If the original consol had a coupon of $25 with an interest rate of 4%, and it was converted into a new consol with the same coupon of $25 and an interest rate of 3.5%, how would the price of the consol change?

-In a March, 2020, Moody’s Analytics Report, chief economist Mark Zandi reported that credit spreads in the bond market have sharply widened. This is a signal of

• positive investor expectations for the future.

• heightened investor angst.
• decreasing rates for speculative-grade commercial paper
• future ratings upgrades for speculative bonds.

Answer 1

Value of a Consol = C/r

C = Coupon payments

r = market interest rate

the original consol had a coupon of $25 with an rate of interest 4%

so value of consol is = C / r

= 25 / 0.04

= $625

a new consol with the same coupon of $25 and an interest rate of 3.5%.

so value of consol is = C / r

= 25 / 0.035

= $714.28

the price of the consol change is $625 to $714.28

If the credit spread tightened, assuming the benchmark US Treasury bond YTM didn't change, the worth of the bond increased, because the corporate bond's YTM would have decreased. On the opposite hand, if the credit spread widened, all else equal, the company bond's YTM increased and therefore the bond price fell.