An investor has two bonds in his portfolio that have a face value of $1000 and pay a 10% annual coupon. Bond L matures in 15 years, and Bond S matures in 1 year.
a. What will be 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?