Zona Estates has just issued a 12-year, 10% coupon rate, €1,000-par bond that pays interest annually. The required return is currently 12%, and the company is certain it will remain at 12% until the bond matures in 12 years.

a. Assuming that the required return does remain at 12% until maturity, find the value of the bond with 

(1) 12 years, 

(2) 10 years, 

(3) 8 years, 

(4) 5 years, 

(5) 1 year to maturity.

b. Plot your findings on a set of “time to maturity (x-axis)–market value of bond (y-axis)” axes constructed similarly to Figure 6.6.

c. Using your graph in part c, explain the relationship between the market value of the bond and the time to maturity when the coupon rate and the expected rates are constant throughout the period.

Figure 6.6

Transcribed Image Text:

FIGURE 6.6 Interest Rate Risk and 140 Bond Characteristics Bond price sensitivity to a 120 change in required return for bonds with different 100 characteristics 80 Change in Bond Price (%) 60 40 20 02 -20 -40 -60 Interest Rate Risk and Bond Characteristics -4 -3 -2 -1 Required Bond Coupon Maturity return A 10% 5 years 10% B 10% 30 years 10% C 6% 30 years 10% D 6% 30 years 6% Change in Required Return (in percentage points) 4 5