Consider newly issued bond A with a three‐year maturity, a 10 percent coupon rate, and a required semiannual yield of 5 percent. Assuming semiannual interest payments of $50 for each of the next six periods, the price of bond A, based on Equation 17‐9, is

The bond’s price should be $1,000 since its coupon rate equals its required yield.

Now consider bond B, with risk identical to bond A, issued five years ago when its required yield was 7 percent. Assume that the bond’s required yield now is 10 percent, or 5 percent on a semiannual basis, and that the bond has three years left to maturity. Investors certainly will not pay $1,000 for bond B and receive $70 coupons per year, or $35 semiannually, when they can pay $1,000 for bond A and receive $100 per year. However, they will pay a price determined by the use of Equation 17‐9.

Equation 17‐9

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σ P(A) = Σ t=1 $50 (1+0.05) $1,000 (1+0.05)6 = = $253.78+$746.21= $999.99, or $1,000