Kim is considering either one of the newly issued 10-year corporate bonds shown in the table below:

The Valuecap bond is extendible at the discretion of the bondholder for an additional five (5) years and both the above bonds are selling at par value and the current yield for each bond is equal to its coupon rate.

Required:

1. If market interest rates decline by 100 basis points (i.e., 1%), calculate the effect of this decline on the price of each bond.
2. If interest rates are expected to fall, evaluate if Robert should select the Valuecap or the EKVE bond?
3. What would be the effect be, if any, of an increase in the volatility of interest rates on the prices of each bond?
4. As can be seen above, although both bond have the same credit rating, suggest two reasons that might explain the lower coupon rate on the Valuecap bond.

Issue size Maturity Coupon % pa (paid semi-annualy) RAM Risk Rating Collateral Callable Par value Call price Sinking fund Valuecap Sdn Bhd RM500 million 10 years* 6% AAA First mortgage Not callable RM100 None None EKVE Sdn Bhd RM150 million 10 years 6.2% AAA General debenture In 10 years RM100 102 Starting in 5 years