Question

An I nvestor has two bonds in his portfolio that have a face value of $1,000 and pay a 7% annual coupon. Bond L matures in 12 years, while Bond S matures in 1 year.

Assume that only one more interest payment is to be made on Bond S at its maturity and that 12 more payments are to be made on Bond L.

What will the value of the Bond L be if the going interest rate is 4%? Round your answer to the nearest cent.

$

What will the value of the Bond S be if the going interest rate is 4%? Round your answer to the nearest cent.

$

What will the value of the Bond L be if the going interest rate is 10%? Round your answer to the nearest cent.

$

What will the value of the Bond S be if the going interest rate is 10%? Round your answer to the nearest cent.

$

What will the value of the Bond L be if the going interest rate is 13%? Round your answer to the nearest cent.

$

What will the value of the Bond S be if the going interest rate is 13%? Round your answer to the nearest cent.

$

Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?

The change in price due to a change in the required rate of return increases as a bond's maturity decreases.

Long-term bonds have greater interest rate risk than do short-term bonds.

The change in price due to a change in the required rate of return decreases as a bond's maturity increases.

Long-term bonds have lower interest rate risk than do short-term bonds.

Long-term bonds have lower reinvestment rate risk than do short-term bonds.

Answer 1

Price of bond S and Bond L is calculated in excel and screen shot provided below:

There is direct relationship between Bond interest rate risk and maturity of bond. For long maturity bond the probability of interest rate is higher than for short term bond. So interest rate risk for long term bond is higher than short term bond.

Longer period bond higher interest rate risk.

Shorter period bonds lower interest rate risk.

So,Option (B) is correct answer