Three $1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

Question

Quizplus · Accepted Answer

The price of Bond A must increase because its current yield is less than its YTM, and interest rates are not expected to change. The current yield on Bond A is:

$80 / $1,000 = 8.0%

Given a YTM of 8.0%, Bond A's price is:

P0 = $80(PVIFA10,8%) + $1,000(PVIF10,8%) = $80(6.710) + $1,000(0.463) = $537 + $463 = $1,000

Thus, the price of Bond A will increase from $970.39 to $1,000 over the next year. Bond B sells at par, so its price should remain at $1,000 as long as interest rates do not change. Bond C has a very high coupon rate, so its price is likely to be more volatile than those of the other two bonds. However, since we are not given any information about changes in interest rates or the number of years until maturity, we cannot determine whether Bond C's price will increase or decrease over the next year.

Three $1,000 Face Value Bonds That Mature in 10 Years