Question

Bond Valuation and Interest Rate Risk

The Garraty Company has two bond issues outstanding. Both bonds pay $100 annual interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and Bond S has a maturity of 1 year.

1. 1. What will be the value of each of these bonds when the going rate of interest is 4%? Assume that there is only one more interest payment to be made on Bond S. Do not round intermediate calculations. Round your answers to the nearest cent.

      Bond L: --------------$  

      Bond S: --------------$  

   2. What will be the value of each of these bonds when the going rate of interest is 9%? Assume that there is only one more interest payment to be made on Bond S. Do not round intermediate calculations. Round your answers to the nearest cent.

      Bond L: --------------$  

      Bond S: --------------$  

   3. What will be the value of each of these bonds when the going rate of interest is 14%? Assume that there is only one more interest payment to be made on Bond S. Do not round intermediate calculations. Round your answers to the nearest cent.

      Bond L: -----------$  

      Bond S: -----------$  

2. Why does the longer-term (15-year) bond fluctuate more when interest rates change than does the shorter-term bond (1 year)?

   I. Longer-term bonds have less reinvestment rate risk than shorter-term bonds.
   II. Longer-term bonds have more interest rate risk than shorter-term bonds.
   III. Longer-term bonds have less interest rate risk than shorter-term bonds.

   -Select- ---------------

Answer 1

a)

Bond value can be calculated using fiancial calculator

Number of periods = N

coupon payment = P

Future value = FV

YTM = I/Y

when interest rate is 4%

Bond L:

[N = 15 ; I/Y = 4% ; PMT = 100 ; FV = 1000] compute PV

Bond S :

[N = 1 ; I/Y = 4% ; PMT = 100 ; FV = 1000] compute PV

Bond L = $1,667.10

Bond L = $1057.69

when interest rate is 9%

Bond L:

[N = 15 ; I/Y = 9% ; PMT = 100 ; FV = 1000] compute PV

Bond S :

[N = 1 ; I/Y = 9% ; PMT = 100 ; FV = 1000] compute PV

Bond L = $1080.61

Bond S = $1009.17

when interest rate is 14%

Bond L:

[N = 15 ; I/Y = 14% ; PMT = 100 ; FV = 1000] compute PV

Bond S :

[N = 1 ; I/Y = 14% ; PMT = 100 ; FV = 1000] compute PV

Bond L = $754.31

Bond S = $964.91

b)

Long term bonds have more interest risk than short term bonds

Option II is correct