Problem:
Lynn Parsons is considering investing in either of two outstanding bonds. The bonds both have $1,000 par values and 11% coupon interest rates and pay annual interest. Bond A has exactly 5 years to maturity, and bond B has 15 years to maturity.
1) Calculate the value of bond A if the required return is (1) 8%, (2) 11%, and (3) 14%.
2) Calculate the value of bond B if the required return is (1) 8%, (2) 11%, and (3) 14%.
3) From your findings in parts a and b, complete the following table, and discuss the relationship between time to maturity and changing required returns.
Required return Value of bond A Value of bond B
8% ? ?
11 ? ?
14 ? ?
4) If Lynn wanted to minimize interest rate risk, which bond should she purchase? Why?