Question 3

Bond X is a 4% coupon bond and Bond Y is an 8% coupon bond. Both bonds require ten years to maturity. Bond Z, similar to Bond X, has the same 4% coupon payment. However, bond Z is a longer-dated bond, with 15 years to maturity. The three issues have a par value of $1,000 and make semi-annual payments. At the moment, the yield-to-maturity (YTM) of the three bonds is 6% p.a. Assume the market is efficient. Answer the following questions:

a) Find out the current price of the three bonds. (6 marks)

b) If interest rates were to suddenly rise by 2%, what would be the respective new price? What if the interest rate were to suddenlyfall by 2% instead? (9 marks)

c) From your answers in parts (a) and (b), what relationship have you observed about the interest rate risk of lower coupon bonds and longer-dated bonds? Complete the following table to assist your explanation.

% Price % Price % Price change ofchange of change of Bond Y Bond Z Interest rates increase by 290 Interest rates fall by 2% (10 marks)