Question

Laurel, Inc., and Hardy Corp. both have 7.3 percent coupon bonds outstanding, with semiannual interest payments, and both are currently priced at the par value of $1,000. The Laurel, Inc., bond has 4 years to maturity, whereas the Hardy Corp. bond has 23 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of these bonds

Answer 1

Use a financial calculator to find out the price of both bonds after the drop in interest rate.

Laurel Bond

When a bond is trading at par, it means that the interest rate is equal to the coupon rate.

Semiannual Coupon = (7.3% * 1,000) / 2 = $36.50

Terms till maturity = 4 * 2 = 8 semi annual periods

Interest rate = (7.3% + 2%) / 2 = 4.65%

Future value = $1,000 par value

Price will come out as $993.20

Percentage change = (993.20 - 1,000) / 1,000 * 100%

= -0.68%

Hardy Bond

Semiannual Coupon = (7.3% * 1,000) / 2 = $36.50

Terms till maturity = 23 * 2 = 46 semi annual periods

Interest rate = (7.3% + 2%) / 2 = 4.65%

Future value = $1,000 par value

Price = $811.53

Percentage change = (811.53 - 1,000) / 1,000

= -18.85%