(Bond

valuation)

You own a bond that pays $120 in annual interest, with a $1,000 par value. It matures in 20 years. Your required rate of return is 10 percent.

a. Calculate the value of the bond.

b. How does the value change if your required rate of return (1) increases to 16 percent or (2) decreases to 6 percent?

c. Explain the implications of your answers in part b as they relate to interest rate risk, premium bonds, and discount bonds.

d. Assume that the bond matures in 4 years instead of 20 years. Recompute your answers in part b.

e. Explain the implications of your answers in part d as they relate to interest rate risk, premium bonds, and discount bonds.