Question 2 (11 marks)

Bond A and Bond B have a face value of $1000. Both bonds have 8% coupon rate and make semimanual payments. Other similar bonds have a yield to maturity (YTM) of 8%. Bond A has 10 years to maturity, whereas Bond B has 30 years to maturity.

1. What should be the price of Bond A when its YTM is 8%?

(1 mark)

2. If YTM rises by 2%, what is the new price of bond A and Bond B? What is the percentage price change of each of these bonds? Show your calculations.

(4 marks)

3. If YTM falls by 2%, What is the new price of each of these bonds? What is the percentage price change of each of these bonds? Show your calculations.

(4 marks)

4. With new lower YTM in point (c), are these premium or discount bonds (why)?

(1 mark)

5. What does this problem tell you about the relationship between the interest rate risk and time till maturity for bonds?

(1 marks)