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Bond Valuation

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The Garraty Company has two bond issues outstanding. Both bonds pay $100 annual interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and Bond S a maturity of 1 year.

a. What will be the value of each of these bonds when the going rate of interest is (1) 5 percent, (2) 8 percent, and (3) 12 percent? Assume that there is only one more interest payment to be made on Bond S.

b. Why does the longer-term (15-year) bond fluctuate more when interest rates change than does the shorter-term bond (1-year)?

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Solution Summary

The solution explains how to calculate the value of a bond.

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a. The value of the bonds is the present value of the principal and interest discounted at the going rate of interest.
(1) 5%
BondS - Value = 100/(1.05) + 1,000/(1.05) = 1,047.62
Bond L - The interest amount is an annuity and we use the PVIFA table to get the present value. The principal amount is a lumpsum ...

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