Question

How many basis points is 1%? (bonds)

a) 1 basis point
b) 10 basis points
c) 100 basis points
d) 1,000 basis points

Answer 1

One percent equates to 100 basis points in the context of bond interest rates. If market interest rates rise, a bond's price typically falls, meaning you would pay less than its face value. The present value calculation is used to determine the actual price you would be willing to pay for the bond.

Step-by-step explanation:

One percent is equal to 100 basis points. When applying this to a bond's interest rate, it's important to understand that a basis point is one hundredth of a percentage point. Therefore, for every 1% change in interest rate, there would be a corresponding change of 100 basis points.

Regarding the bond example provided:

• If a $10,000 bond was issued at 6% and the interest rates are now 9%, you would expect to pay less than the face value of $10,000 for the bond because the current market interest rates are higher than the bond's coupon rate.

To calculate what you would actually be willing to pay for this bond:

• You need to find the present value of the bond's cash flows (the final year's interest and the principal repayment) discounted at the new interest rate of 9%.