Response to the following problem:
Consider two bonds, HI and LI. The HI bond has a 10% coupon rate and the LI bond has a 5% coupon rate. Both bonds pay interest annually and are priced to yield 10%. Suppose the following interest scenarios are possible at the point in time when both bonds have five years remaining to maturity:
Possible Interest Rate Probability of Interest Rate
5% 10%
10 50
15 40
a. Calculate the expected value for each bond.
b. Calculate the standard deviation of possible values for each bond.
c. Which bond is riskier? Why?