Question

Last year a firm issued 20-year, 8% annual coupon bonds at a par value of $1.000. Suppose that one year later the going market interest rate drops to 5%. What is the new price of the bonds, assuming they now have 19 years to maturity?

a) None of these are correct
b) $1520
c) $1362.56
d) $985.72
e) $1000

Answer 1

To calculate the new price of the bonds, we can use the formula for present value of a bond. Plugging in the values from the question, the new price of the bond, assuming it now has 19 years to maturity, is c) $1362.56.

Step-by-step explanation:

To calculate the new price of the bonds, we need to consider the change in the market interest rate. The price of a bond is inversely related to the market interest rate - as interest rates decrease, bond prices increase, and vice versa.

In this case, the market interest rate dropped from 8% to 5%. Since the coupon rate of the bond remains the same at 8%, the bond's new price will be higher than its original price.

To calculate the new price, we can use the formula for present value of a bond:

P = C * (1 - (1 + r)^(-n)) / r + F * (1 + r)^(-n)

Where:

• P is the bond's price
• C is the annual coupon payment
• r is the market interest rate
• n is the number of periods remaining until maturity
• F is the face value of the bond

Plugging in the values from the question, we will find that the new price of the bond, assuming it now has 19 years to maturity, is $1362.56 (option c).