Consider the following two bonds: a 5-year and a 10-year bond, each with a 7% coupon....

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Finance

Consider the following two bonds: a 5-year and a 10-year bond,each with a 7% coupon. Both bonds currently sell at par and couponpayments are made annually (i.e., one coupon payment per year).
(a) What is the current price of each bond?
Hint: answer does not require calculations; read description ofbonds carefully to determine what price must be (10 points) Supposeyou buy the 10-year bond. One year later, interest rates decreaseto 5%.
(b) What will be the new price of the bond? (30 points)
(c) What rate of return would you have earned on the bond overthe one-year period? (20 points)
(d) Which bond will have a higher rate of return over the year,the 5-year bond or the 10-year bond? Why? (5 points).
You don’t need calculations for this one and will not be givenany points for a numerical answer; respond based on yourunderstanding of interest rate risk (price sensitivity) inbonds.

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4.3 Ratings (743 Votes)

a Current price of each bond is 1000 as they sell at par b Price of a bond is the PV of the expected cash flows from the bond if it is held till See Answer

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