The fixed income nature of bonds implies that the price of these securities is highly sensitive to interest rate changes. For the following bond a three-year $1,000 bond with a 8% annual coupon with a market interest rate, or
The fixed income nature of bonds implies that the price of these securities is highly sensitive to interest rate changes. For the following bond – a three-year $1,000 bond with a 8% annual coupon with a market interest rate, or YTM of 3%, 1) calculate the duration for the bond and 2) assuming interest rates rise to 5%, what is the approximate impact to the bond price?
- Expert Answer
SOLUTION 1 To calculate the duration of the bond we can use the following formula Duration Present v View the full answer
Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.