Question

Which of the following bonds has the highest interest rate risk? All bonds have the same face value and make annual coupon payments.

A. 10-year bonds with 5% coupon rate B. 10-year bonds with 4% coupon rate C. 10-year bonds with 3% coupon rate D. 5-year bonds with 6% coupon rate E. 5-year bonds with 5% coupon rate

The Grand Adventure has a 7-year, 6 percent annual coupon bond outstanding with a $1,000 par value. The bond has a yield to maturity of 5.5 percent. Which one of the following statements is correct if the market yield suddenly increases to 7 percent?
A. The bond price will increase by $57.14.
B. The bond price will increase by 5.29 percent.
C. The bond price will decrease by $53.62.
D. The bond price will decrease by 8 percent.
E. The bond price will decrease by 8.36 percent.

Which one is correct and why?

Answer 1

1. bonds with high maturity period and lower coupon rates affects more by the interest risk.

Option C is correct which have "10-year bonds with 3% coupon rate" high maturity period and lower coupon rate.

2. To find the price of the bond, use PV function in EXCEL

=PV(rate,nper,pmt,fv,type)

rate=yield to maturity =5.5%

nper=7 years

pmt=coupon=coupon rate*face value=6%*1000=60

fv=face value=1000

=PV(5.5%,7,60,1000,0)=$1028.41

If Yield to maturity increases to 7%, then rate=7%

=PV(7%,7,60,1000,0)=$946.11

The price of the bond falls by=$1028.41-$946.11=$82.31

The Percentage of bond price decreases by=$82.31/1028.41=8.0%

Option D is correct