Question

1. Why are long-term, fixed-rate bond values more sensitive to interest rate changes than short-term, fixed-rate bond values?

(Maximum 4 sentences, maximum 100 words.)

2. 2 years ago, you paid $1069 for a $1,000 par bond that has a 7% coupon with semiannual payments. You are selling it today for $1000. You reinvested coupons at the 2.2% annual rate. What is your total return? (Report your answer to two decimals, without the % symbol. E.g., if your answer is 5.1538%, enter it as 5.15.)

3. You paid $957 for a $1,000 par, 8-year bond with a 6% coupon rate and annual payments. You are selling it today, after receiving 3 coupon payments, for $1070. You reinvested coupons at the 4.1% annual rate. What is your total return? (Report your answer to two decimals, without the % symbol. E.g., if your answer is 5.1538%, enter it as 5.15.)

4. What is the price of a bond (to the nearest cent) with 17 years to maturity, 5.8% coupon rate, semiannual payments, par of $1000, and the yield to maturity of 6.73%?

5. What is the duration (D) of a 2-year bond with a $35 annual coupon (paid annually), $1,000 par, and a yield of 6.4%? Record your answer to the nearest 0.001 years.

6. A bond with a $1,000 par, 5 years to maturity, a coupon rate of 3%, and annual payments has a yield to maturity of 3.7%. What will be the actual percentage change in the bond price if the yield changes instantaneously to 5.5%? (If your answer is, e.g., 1.123%, enter it as 1.123.)

7. A bond with duration of 3.4 years has a yield of 4.94%. If the yield changes to 4.05%, what percentage price change would the duration measure predict? (Report your answer to three decimals, without the % symbol. E.g., if your answer is -5.342%, report it as -5.342.)

Answer 1

Q. Why are long-term, fixed-rate bond values more sensitive to interest rate changes than short-term, fixed-rate bond values?

The coupon rate or interest rate on a bond is fixed at the time the bond is issued, and the only way to change the bonds value is to change the price of the bond (discount or premium). If the rates fall, the investor will be underpaid for however many coupon payments are left on the agreement, which could be a lot. Therefore when you buy a long term bond you have a greater risk of market fluctuation and interest rate risk, that is much lower in short term bonds.

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