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Both Bond Sam and Bond Dave have 7% coupons, make semiannual payments and are priced at par

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Both Bond Sam and Bond Dave have 7% coupons, make semiannual payments and are priced at par value. Bond Sam has three years to maturity, whereas Bond Dave has 20 years to maturity. If interest rates suddenly rise by 2%, what is the percentage change in the price of Bond Sam? Of Bond Dave? If rates were to suddenly fall by 2% 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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Any bond that sells at par has a YTM equal to the coupon rate Both bonds se...View the full answer


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Fundamentals Of Corporate Finance

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Authors: Stephen Ross, Randolph Westerfield, Bradford Jordan, Gordon Roberts, J. Ari Pandes, Thomas Holloway

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Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.

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