Suppose you invest in a 5 year coupon bond, with a coupon rate of 5%. Coupons are paid once a year and the par value is 1000. The interest rate today is 4%. Assume your investment horizon is 5 years.
1. What is the price of the bond today?
2. Suppose that one year has passed and now the interest rate fell to 2% and you know for sure it will stay that way for all subsequent years. Will you prefer to keep that bond until maturity or sell it now and buy a 4-year zero coupon bond (assume you can buy fractions of a bond, for example half a bond etc.)?