Question

Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $60 annually. Bond A will mature in eight years, while bond B will mature in ten years. If the yields to maturity on the two bonds change from 7% to 5%,

	A.	both bonds will increase in value, but bond A will increase more than bond B.
	B.	both bonds will decrease in value, but bond B will decrease more than bond A.
	C.	both bonds will increase in value, but bond B will increase more than bond A.
	D.	both bonds will not change in value.
	E.	both bonds will decrease in value, but bond A will decrease more than bond B.

Answer 1

The correct answer is Option C

The Coupon rate of both bonds is = Coupon / Face value

= 60/1000 which is 6%

Now, The yield is less than the coupon rate which is 5%, this means the coupon rate is higher than the yield, this will push the bond price upwards because the bond price is the accumulated present value of all the payments that it is going to generate and it is discounted by the interest rate which is yield to arrive at the present value.

If the interest rate (yield) falls then the present value of bond price will be more than the face value because the less discount rate will lead to more value.

The Duration of bond also affects the bond price, the more the maturity of years the more will be the value of shares as the future payments get accumulated to the share price which push the bond price to go up.