Memo 3

On January 1, 2016, Jennifer Baker started to work as an intern in the fixed-income department of

the Traveler Mutual Funds. Her supervisor, Linda Brown, assigned her to analyze interest rate risk

associated with investment in bonds issued by DTE Energy. Ms. Brown provided Jennifer with the

information about four bonds issued by DTE Energy. The four bonds are named as A, B, C, and D.

Bond A

Bond B

Bond C

Bond D

Price on January 1, 2016

123

125

101

103

3

Annual coupon rate

5.8%

5.8%

1.625%

5.4%

Maturity date

12/31/2040

12/31/2036

12/31/2017

12/31/2017

Par value

$1,000

$1,000

$1,000

$1,000

Coupon payment frequency

Semiannual

Semiannual

Semiannual

Semiannual

Rating

A

A

A

A

Then, Ms. Brown assigned Jennifer to do the following research jobs based on the information:

1. Calculate the yield to maturity for the four bonds on January 1, 2016, respectively.

2. Based on the macroeconomic data released by the National Bureau of Economic Research, Ms.

Brown expected that inflation rate will increase by 1%. Hence, she expected that yield to maturity

for the four bonds will increase by 1% too. She asked Jennifer to calculate prices of the four bonds

if the yield to maturity increases by 1%, respectively.

3. List the bond prices of the four bonds on January 1, 2016 and the bond prices of the four bonds

calculated in 2) when the yield to maturity increases by 1% in a table. Jennifer next calculated the

percentage price change of the four bonds.

4. Since Bond A and Bond B have the same coupon rates, Ms. Brown asked Jennifer to compare

which bond price will drop more when the yield to maturity increases by 1%? Since Bond C and

Bond D have the same maturity date, Ms. Brown asked Jennifer to compare which bond price

will drop more when the yield to maturity increases by 1%?

5. Based on the results in 1) through 4), Jennifer needed to report to Linda Brown about which bonds

have higher interest rate risk and why.

Suppose that you are Jennifer Bake and write a short memo addressing 1 through 5 to Ms. Brown. PLEASE SHOW ALL WORK!