Question

# Which of the following bonds has the highest interest rate risk? All bonds have the same...

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?

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

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