Assume that a $1,000 par value bond with a coupon rate of 7.5% (paid semi-annually) has 20 years to maturity.
a. If the current rate of interest on bonds like this is 9%, what will be the price of the bond? What is the price if current interest rates are instead 6%?
b. Assume that you buy the bond described above when interest rates are 9%. Five years later, you decided to sell the bond when current interest rates are still 9%. At what price will the bond be selling? Do the same assuming that you buy the bond when interest rates are 6%, and five years later they are still 6%.
c. Now assume that you purchase the bond in part a above when interest rates are 9%, and five years later interest rates are 11%. What will be the price of the bond? What percentage gain or loss would you incur in the value of this bond?
d. What is the current yield and capital gains yield on this bond under each of the two conditions in part a?