An investor has two bonds in his portfolio that both have a facevalue of 1000 and pay a 10 percent annual coupon. Bond L matures in15 years, while Bond S matures in 1 year.
a) What will the value of each bond be if the going interest rateis 5 percent, 8 percent, and 12 percent? Assume that there is onlyone more interest payment to be made on Bond S, at it maturity, and15 more payments on Bond L.
b) Why does the longer-term bond's price vary more when interestrates change than does that of the shorter-term bond?