Question

Milner's Tools has a 9-year, 7 percent annual coupon bond outstanding with a $1,000 par value. Carter's Tools has a 10-year, 6 percent annual coupon bond with a $1,000 par value. Both bonds currently have a yield to maturity of 6.5 percent. If the market yield increases to 6.75 percent,

(1) What is the percentage change in Milner’s bond value?

(2) What is the percentage change in Carter’s bond value?

(3) Whose bond has higher interest rate risk? Why?

Answer 1

Value of a bond is given by the excel function, PV = PV(R,N,PMT,FV)

R - YTM

N - years to maturity

PMT - Coupon

FV - Par value

Coupon = Coupon rate * par value

1 - % change in Milner's bond value = -1.63%

2 - % change in Carter's bond value = -1.80%

3 - Carter's bond has higher interest rate risk. This is because as the term to maturity increases, the bond is more susceptible to interest rate change.