Question

Laurel, Inc., and Hardy Corp. both have 8 percent coupon bonds outstanding, with semiannual interest payments, and both are currently priced at the par value of $1,000. The Laurel, Inc., bond has five years to maturity, whereas the Hardy Corp. bond has 16 years to maturity. a. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of each bond

Answer 1

Answer:

Laurel bond will decrease by 7.72%

Hardy bond will decrease by 15.8%

Explanation:

current bond price $1,000

interest rate 8%

Laurel bond matures in 5 years, 10 semiannual payments

Hardy bonds matures in 16 years, 32 semiannual payments

if market interest increases to 10%

Laurel bond:

$1,000 / (1 + 5%)¹⁰ = $613.91

$40 x 7.7217 (annuity factor, 5%, 10 periods) = $308.87

market price = $922.78

% change = -7.72%

Hardy bond:

$1,000 / (1 + 5%)³² = $209.87

$40 x 15.80268 (annuity factor, 5%, 32 periods) = $632.11

market price = $841.98

% change = -15.8%