2. 19. Interest rate risk [LO 7.2] Both Bond Sam and Bond Dave have 7.3 per cent...

Question:

2. 19.

Interest rate risk [LO 7.2] Both Bond Sam and Bond Dave have 7.3 per cent coupons, make semiannual payments and are priced at face value. Bond Sam has three years to maturity, whereas Bond Dave has 20 years to maturity. If interest rates suddenly rise by 2 per cent, what is the percentage change in the price of Bond Sam? Of Bond Dave? If rates were to suddenly fall by 2 per cent instead, what would the percentage change in the price of Bond Sam be then? Of Bond Dave?

Illustrate your answers by graphing bond prices versus YTM. What does this problem tell you about the interest rate risk of longer-term bonds?

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