Bond valuation
Company ABC has two bonds outstanding. Bond A has a coupon rate of 8%, face value of $100, and maturity of 10 years. Bond B has a coupon rate of 6%, face value of $100, and maturity of 20 years.
The default risk premium for Bond A and Bond B is 0.75%. The maturity risk premium for Bond A is 1% and for Bond B is 1.5%. The 30-day T-bill rate is 3%.
1. Determine the rate of return required by Bond A investors. Determine the required rate of return for Bond B investors.
2. Determine the value of Bond A and the value of Bond B.
3. If interest rate goes up by 1%, what is the value of Bond A and what is the value of Bond B? What is the rate of change in the value of Bond A and what is the rate of change in the value of Bond B?
4. Use the example above, describe the relationship between bond value and interest rate. Use the example above, explain why long term bonds are riskier than short term bonds.