7-5

BOND VALUATION: An investor has two bonds in his portfolio that have a face value of $1,000 and pay an 11% annual coupon. Bond L matures in 12 years, while Bond S matures in 1 year.

What will the value of each bond be if the going interest rate is 6%, 8%, and 12%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 12 more payments are to be made on Bond L.

Why does the longer-term bond's price vary more than the price of the shorter-term bond when interest rates change?

7-9

YIELD TO MATURITY: Harrimon Industries bonds have 6 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 10%.

What is the yield to maturity at a current market price of (1) $865 and (2) $1,166?

Would you pay $865 for each bond if you thought that a "fair" market interest rate for such bonds was 12%that is, if rd=12% ? Explain your answer.