Question

Lynn Parsons is considering investing in either of two outstanding bonds. The bonds both have ​$1,000 par values and 12​% coupon interest rates and pay annual interest. Bond A has exactly 6 years to​ maturity, and bond B has 16 years to maturity.  

a.  Calculate the present value of bond A if the required rate of return​ is: (1) 9​%, ​(2) 12​%, and​ (3) 15​%.

b.  Calculate the present value of bond B if the required rate of return​ is: (1) 9​%, (2) 12​%, and​ (3) 15​%.

c. From your findings in parts a and b​, discuss the relationship between time to maturity and changing required returns.

d.  If Lynn wanted to minimize interest rate​ risk, which bond should she​ purchase? ​ Why?

Answer 1

FV=1000, Coupon= 1000*0.12=120

Bond A Bond B rate 6 16 0.09 $   1,134.58 $   1,249.38 0.12 $   1,000.00 $   1,000.00 0.15 $      886.47 $      821.37

Formula: for Bond A at 9%: =PV(0.09,6,120,1000)

c) As time to maturity increases at a given rate, the present value of bonds fall due to more periods of discounting to the present value.

As the required return increases, the present value decreases duw to larger amount of discounting per period.

d) She shall purchase bond A because its value is less susceptible to changes in interest rates. It can be seen that bond A due to lower periods till maturity changes less in value as compared to bond B.