Question

Bond 1 and Bond 2 both have a face value of $1,000. Bond 1 pays a 5% coupon (annual payments) while Bond 2 is a zero coupon bond. On November 30, 2014 (immediately after the annual coupon payment), Bond 1 had exactly 20 years to maturity, while Bond 2 had 15 years to maturity. The yield to maturity for each bond was 10% on November 30, 2014, and was 8% on November 30, 2015.

E. Which bond was more “sensitive” to this interest rate change, and why? In your answer to this question, address the following items: • Based upon “time to maturity,” which bond should be more sensitive to the interest rate change? • Based upon the relative size of the coupon payments, which bond should be more sensitive to the interest rate change? • Which of these two effects dominated in this case? How do you know (other than by looking at your answers to Part D)?

Answer 1