Question

A 10-year coupon bond with a $5,000 face value has an interest rate of 12% APR. The coupon rate is 8% and the payments are semiannual. What would be the change in the bonds value if the 10-year interest rate were to drop by 1%. Select one:

a. increase by 313.23

b. decrease by 313.23

c. decrease by 250.71

d. increase by 250.71

Answer 1

Value of Bond is equal to the present value of all coupon payments and the principal amount

Value of Bond now

= 200*PVAF(6%, 20 periods) + 5,000*PVF(6%, 20 periods)

= 200*11.470 + 5,000*0.312

= $3,854

If interest rate drops by 1%,

Value = 200*PVAF(5.5%, 20 periods) + 5,000*PVF(5.5%, 20 periods)

= 200*11.950 + 5,000*0.343

= $4,105

Hence, value of bond d. increase by 250.71 (approx.)

Correct answer is d.