Northern Electric has many bonds trading on the NY Stock Exchange.
Suppose NEs bonds have identical coupon rates of 8% but that one issue matures in one year, one in 5 years and the third in 10 years. Assume that a coupon payment was made yesterday.
a. If the yield to maturity for all three bonds is 9%, what is the fair price of each bond?
b. Suppose that the yield to maturity for all these bonds changes instantaneously to 7%. What is the fair price of each bond now?
c. Suppose that the yield to maturity for all of these bonds changed instantaneously again this time to 10%. Now what is the fair price of each bond?
d. Based on the fair prices at the various yields to maturity, is interest-rate risk the same, higher, or lower for longer-versus shorter maturity bonds?© BrainMass Inc. brainmass.com June 4, 2020, 2:10 am ad1c9bdddf
This solution illustrates how to compute the fair price of bonds, how to recompute the price if interest rates change, and the interest rate risk relative to length of maturity.