Question

The Penn Railways has a 7-year, 6.5 percent semiannual coupon bond outstanding with a $1,000 par value. The bond has a yield to maturity of 5.5 percent. What will happen to the bond price if the market yield suddenly increases to 7 percent?

Answer 1

Answer:

The increase in yield to maturity from 5.5% to 7% will cause the price of the bond to fall from $ 1,057.46  to $ 972.70  

Explanation:

In order to ascertain the impact on the bond of a sudden increase in the yield to maturity from 5.5% to 7%, the present value of the bond, the current price is computed using yield of maturity of 5.5% and 7% respectively.

In calculating the present value, a discounting factor is used to state today's value of the future cash flows from the bond, given as 1/(1+r)^N, where r is the yield to maturity divided by 2 , in order to show that the bond is a semi-annual  interest paying bond.The fact that the bond is a semiannual one means interest would be paid 14 times( 7 years *2)

The present value is computed in the attached.

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