Question

A company has two outstanding bond issues, both with a coupon rate of 10%. bond a will mature in 3 years while bond b will mature in 20 years. if interest rates were to decrease to 8%, which of the following statements is correct?

Multiple Choice:
A. Bond A will have a higher market value than Bond B.
B. Bond B will have a higher market value than Bond A.
C. Bond A and Bond B will have the same market value.
D. The market values of both Bond A and Bond B will increase.
E. The market values of both Bond A and Bond B will decrease.

Answer 1

When interest rates decrease, the market value of existing bonds usually increases. In this case, Bond A will have a higher market value than Bond B. The Correct Answer is Option A.

Step-by-step explanation:

When interest rates decrease, the market value of existing bonds usually increases.

This is because the fixed interest payments provided by the bond become more attractive compared to other investments.

In this case, Bond A has a shorter maturity period of 3 years compared to Bond B's 20 years.

Since interest rates have decreased, Bond A's shorter maturity will impact its market value more positively than Bond B, making statement A correct. Bond A will have a higher market value than Bond B.