Keller Corp. has an outstanding issue of $1,000 par value bonds with a 5.00% coupon rate, paid semiannually. The issue matures in 17 years. Bonds of similar risk are currently earning a 11.00% rate of return (annualized nominal yield). Consider why a bond might be earning a yield below the coupon rate. What might have happened? I will ask in class. However, Brightspace really only handles quantitative questions well. So here I have a different question. There is a particular yield known as the "current yield" (to be clear, this is not another way of saying today's yield). What is it for this bond? Answer in percent to three decimal places. Do not enter the percent sign. Imagine two bonds. Both mature in 12 years, and have annual coupons. They both yield 10%. One has a coupon of 5% (call it the low coupon bond), and one has a coupon of 11% (call it the high coupon bond). Now imagine that the yield for both rises from 10% to 12%. Which bond will have the greatest price change in percentage terms? Answer below. Note that this is a question about interest rate sensitivity, and addresses something called the coupon effect. (It is also really a duration questionwhich we will get to later in the course.) You may already know the answer to this. But if you don't you can simply do actual calculations using the bonds I describe above. Calculate the original price, then calculate the new price after the yield rises. The calculate percentage price changes. You will see the answer. The question you must answer is a true/false. The following statement is true or false: The high coupon bond will have the greatest percentage price change? True False You own two $1,000 par bonds, one in this problem and one in the next. I want to illustrate something else. Both of these bonds are zero coupon bonds, which simply means they pay no coupon. The first bond matures in 5 years, and yields 8%. If the required yield drops to 6% (instantaneously, so the maturity does not change), what is the percentage price change? Answer in percent to three decimal places. Do not enter the percent sign. Do enter the sign if negative. Assume annual compounding. OK, this is the second zero coupon bond. This one also has a par value of $1,000. This one matures in 20 years, and yields 8%. If the required yield drops to 6% (instantaneously, so the maturity does not change), what is the percentage price change? Answer in percent to three decimal places. Do not enter the percent sign. Do enter the sign if negative. Assume annual compounding. Again, be sure to compare the results of this problem and the last. The only thing different between the two bonds is maturity. What does this tell you about maturity and the interest rate sensitivity of the bond? I assume by now you have been reminded several times of the relationship between the direction of the interest rate change and the direction of the price change
