Instead of XYZ Co. stock, you are considering purchasing its bonds. Suppose XYZ issues a series of bonds originally sold at par value. The maturity is 15 years and the coupon rate is 5%, paying a semi-annual coupon.

• Suppose your purchase the bond at par value, what is your expected YTM? If you bought the bond at a discount what would your YTM be?

• Suppose the economy changes such that interest rates are now 3%, what would the initial price of the bond be?

• Suppose interest rates increase to 6%, what would the initial price of the bond be?

• Suppose you are expecting interest rates to fall in the future, which of the following bonds would you be most interested in? Circle your answer. (Hint: Assume default risk is zero and consider bond duration.)
  • The bond described above.
  • A 10-year zero-coupon bond with a YTM of 5%.
  • A 20-year zero-coupon bond with a YTM of 5%.
  • A 10-year bond with a 5% coupon rate with a YTM of 5%.