Question

QUESTION 5

1. Bond X and Bond Y are both zero coupon bonds that pay annually and have a 7% yield. Bond X matures in 5 years and Bond Y matures in 13 years. Calculate the percentage change in the price of each bond if interest rates suddenly decreased by 1.5%.

   		Bond X: 6.82%, Bond Y: 16.77%
   		Bond X: -6.82%, Bond Y: -16.77%
   		Bond X: -7.31%, Bond Y: -20.15%
   		Bond X: 7.31%, Bond Y: 20.15%
   		None of the above.

QUESTION 6

1. All else equal, the longer the time to maturity, the lower the interest rate risk. This is because longer-term bonds take a longer period of time to repay the lender.

   True

   False

QUESTION 7

1. All else equal, the larger the coupon rate on a bond, the lower the interest rate risk. This is because higher coupon rates have larger coupon payment early in its life.

   True

   False

Answer 1

Q5: Option 4 is right

Using financial calculator

Bond X:

Input: FV= 1000

N =5

I/Y =7

Solve for PV = -712.99

Input: FV= 1000

N =5

I/Y =5.5

Solve for PV = -765.13

Change = (765.13-712.99)/712.99 = 7.31%

BOND Y:

Using financial calculator

Input: FV= 1000

N =13

I/Y =7

Solve for PV = -414.96

Input: FV= 1000

N =13

I/Y =5.5

Solve for PV = -498.56

Change = (498.56- 414.96)/414.96 = 20.15%

Q6: False

(Longer term means greater risk of default)

Q7: True

A higher coupon implies that more cash goes to the investor before maturity as interest payments. Hence the interest rate risk is lower.