An investor has two bonds in his portfolio that have a face value of $1,000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year.
a. What will the value of each bond be if the going interest rate is 5%, 8%, and 12%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 15 more payments are to be made on Bond L.
b. Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?
Six years ago the Singleton Company issued 20-year bonds with a 14% annual coupon rate at their $1,000 par value. The bond had a 9% call premium, with 5 years of call protection. Today Singleton called the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Explain why the investor should or should not be happy that Singleton called them.