Problem: John Wilson is a conservative investor who has asked your advice about two bonds he is considering. One is seasoned issue of the Capri Fashion Company that was first sold 22 years ago at a face value of $1000, with a 25-year term, paying 6%. The other is a new 30-year issue of the Gantry Elevator Company that is coming out now at a face value of $1000. Interest rates are now 6%, so both bonds will pay the same coupon rate.
Q1. What is each bond worth today? (No calculations should be necessary.)
Q2. If interest rates were to rise to 12% today, estimate without making any calculations what each bond would be worth.
Q3. Calculate the prices in part b to check your estimating ability. If interest rates are expected to rise, which bond is the better investment?
Q4. If interest rates are expected to fall, which bond is better? Are long-term rates likely to fall much lower than 6%? Why or why not?