Question

Suppose that you are considering the purchase of a coupon bond with a face value of $1,000 that matures after four years. The coupon payments are 6 percent of the face value per year.

a. How much would you be willing to pay for this bond if the market interest rate (that is, the best alternative investment option) is also 6 percent?

b. Suppose that you have just purchased the bond, and suddenly the market interest rate falls to 5 percent. What is the bond worth now?

c. Suppose that one year has elapsed, you have received the first coupon payment, and the market interest rate is still 5 percent. How much would another investor be willing to pay for your bond?

d. Suppose that two years have elapsed since you purchased the bond, and you have received the first two coupon payments. Now suppose that the market interest rate suddenly jumps to 10 percent. How much would another investor be willing to pay for your bond?

Answer 1

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