Interest rate risk is the risk that interest rates will increase and bond prices will fall , thereby lowering the prices on older bond issues and ensuring that an older bond and a newly issued bond offer investors approximately the same yield. Bonds generally have a fixed yield but a variable value. Suppose you own a 30-year bond issued by Twin-Cities Power & Light with a face value of $1,000 paying a semiannual coupon interest rate of 6% that has 10 years remaining until maturity. If interest rates in the general economy jump to 8% after one year, no one will want to buy your 6% bond for $1,000, because it pays only $ per year in interest. If you want to sell the bond, then the bond price will have to be lowered raised If rates on similar bonds are now at 8%, then the discount rate is 8% (or 4% twice a year for 20 payments). The task is to calculate the present value of the interest payments and the repayment lump sum. To do so, use Appendix A-2 and Appendix A-4 in your textbook. Find the column for 4% interest and the row for 20 periods. (The number of periods, n, is equal to 20, because there are 20 semiannual interest payments in the remaining 10 years until the bond matures.) You can use the following equation to determine the value of a bond (or bond selling price): The Value of Bond (Bond Selling Price Formula Value of Bond = Present Value of Interest Payments + Present Value of Lump Sum (Annual Interest Payment/2 x PVIFAI,n) + (Lump Sum x PVIFI,n) where: New annual interest rate divided by 2 (because interest payments are semiannual) Number of years to maturity times 2 (because interest payments are semiannual) Present value interest factor of annuity (from Appendix A-4 in your textbook) Present value interest factor (from Appendix A-2 in your textbook) PVIFAIn = PFIFn = Use this equation to calculate the present value (selling price) of your $1,000 bond issued by Twin-Cities Power & Light. The values of PVIFA and PVIF (from Appendix A-4 and Appendix A-2, respectively) have been provided for you. If required, round your answer to the nearest cent. Value of Bond = Present Value of Interest Payments + Present Value of Lump Sum (Annual Interest Payment/2 x PVIFA4%,20) + (Lump Sum PVIF4%,20) ($ O 12 x 13.5903) + ($ O 0.4564) ($ x 13.5903) + ($ C x 0.4564) Now suppose that the interest rate has fallen instead of risen. If the interest rate falls below the coupon rate (stated interest rate) of your bond, then the price of your bond would the bond's face value. This is because investors are willing to pay more to own a bond that offers a yield that is higher than the current interest rate. The difference between a bond's face value and its higher selling price is called a premium fee penalty fine