Question

Problem Solving Questions (Please Show All Your Work) (70 pts)] Problem I (22 points) Bond A is a 15 -year, $1,000 face value bond that pays semiannual coupon payments of $40. It was issued 3 years ago. If the annual required rate of return on similar bonds with similar

a) Compute the current price for this bond.
b) Compute the annual coupon rate.
c) Compute the current yield.
d) If the interest rate goes up by 2% compute the price of bond A
e) Calculate the percentage % change in price
f) Bond B is a 15 year bond, $1,000 face value bond and pays semiannual coupon payments of $50. Bond B was also issued 3 years ago. If the prevailing annual required rate of return (i.e. 10% ) increases by 2%, which of bond A or B would have the largest percentage change in price Explain without showing calculations.

Answer 1

Bond valuation is influenced by interest rate changes. Higher coupon payments and longer maturity result in greater sensitivity to these changes. An increase in market interest rates leads to a decrease in bond prices.

Step-by-step explanation:

The subjects encompassed by the questions relate to the calculation of bond values and the impact of changing interest rates on those values, a fundamental concept in finance. Specifically, the questions are asking for the calculation of present values of bonds given different coupon payments and interest rates. The questions also expect an understanding of the relationship between market interest rates and bond prices, as well as the duration of a bond's sensitivity to changes in interest rates.

To determine the change in bond price due to an increase in the market interest rate, one must understand that the price of a bond moves inversely to changes in interest rates. For example, for Ford's bond with a 3% interest rate that experiences a market increase to 4%, the bond's value will decrease. When comparing bonds A and B, where bond B has a higher coupon payment, it will generally be more sensitive to interest rate changes due to having higher cash flows in the future, leading to a greater change in present value.

In summary, when interest rates rise, bond prices fall, and the percentage change in bond price is influenced by the size of the coupon payments and the bond's remaining time to maturity. The more substantial the payment stream and the longer the maturity, the greater the bond's price will react to changes in the interest rate, known as its duration.