Unlike equities, bond valuation is more complicated by the specific characteristics of the bond itself as outlined in the bond indenture, the external economic environment, and the current interest rate, and in some cases the characteristics of the investor. The following assignment provides you an ability to see just how these characteristics affect a plain vanilla bond.
Given the following bond: 30 years, 5.25% semiannual AAA corporate bond in its 10th year of issue. The current market interest rate is 4.75%.
What is the current price of the bond?
What would be the effect of a change in the market price of the bond if the market interest rate increased to 5%? Calculate the difference.
If this bond was callable, what would be the effect on market price over a non-callable bond? Would the price be higher, or lower?
If this bond was a sinking fund bond, what would be the effect on market price compared to a non-sinking fund bond? Would the price be higher, or lower? Explain.
What the effect would be on these two investments if the Federal Reserve announces a raise in the interest rate of .5% (the Federal Funds rate actually); effective immediately.