Question

.1. Explain the relationship between bond price and years remaining the maturity.

.2. Suppose a bond with a 14% coupon rate and semiannual coupons with 12% YTM and has a face value of $1000, 10 years to maturity.

What is the price of the bond?

Is this a premium or discount bond?

Answer 1

1. The higher the duration, the more a bond's price will drop as interest rates rise (and the greater the interest rate risk). As a general rule, for every 1% change in interest rates (increase or decrease), a bond's price will change approximately 1% in the opposite direction, for every year of duration.

2. $P = 140*(1-(1+0.12/2)^{-20})/0.06) + 1000/(1+0.06)^{20} = 1,917.59.$

This is a premium bond, as the price is above the face value.