Back to Assignment
Attempts
Score / 4
10. Problems and Applications Q3
Bond A pays $4,000 in 14 years. Bond B pays $4,000 in 28 years. (To keep things simple, assume these are zero-coupon bonds, which means the
$4,000 is the only payment the bondholder receives.)
Suppose the interest rate is 5 percent.
Using the rule of 70, the value of Bond A is approximately
Now suppose the interest rate increases to 10 percent.
Using the rule of 70, the value of Bond A is now approximately
and the value of Bond B is approximately
Comparing each bond's value at 5 percent versus 10 percent, Bond A's value decreases by a
, and the value of Bond B is approximately
percentage than Bond B's value.
The value of a bond
when the interest rate increases, and bonds with a longer time to maturity are
sensitive to changes in the interest
rate.