Question

Bond A is a 6 % coupon bond and makes annual payments with 10 years to maturity. Bond B is a 6% coupon bond and makes annual payments with 20 years to maturity. Both bonds have a market required return of 10% and face value of 1,000.

Calculate the percentage change in price of each bond. Which bond does carry greater interest rate risk? Why? Show your work.

Answer 1

Let us find the price of the bond using pv formuale in excel.pv(ratenper,pmt,fv,type)

Bond A=pv(10%,10,(1000*6%),1000,0)=754.22

Bond B=pv(10%,20,(1000*6%),1000,0)=659.46

Let us now find the price of the bond if market required return chnages to 12%

Bond A=pv(12%,10,(1000*6%),1000,0)=660.99

Bond B=pv(12%,20,(1000*6%),1000,0)=551.83

% chnage in Bond A=(754.22/660.99)-1=14.10%

% chnage in Bond B=(659.46/551.83)-1=19.50%

Bond B carriers highest rate risk since it is having longer maturity time so greater risk of chnage in interest rates