You purchased a zero-coupon bond last week for $499. The bond promised to pay $1,000 in ten years. Since your purchase, prevailing interest rates have increased by 50 basis points. If
You assume no other changes have occurred that would affect your bond's price, which of the
Following statements is necessarily true?
A)The value of your investment has decreased to about $476.
B)The value of your investment has decreased to about $449.
C)The value of your investment has increased to about $549.
D)The value of your investment has stayed the same since this is a zero-coupon bond.

Question

Quizplus · Accepted Answer

When prevailing interest rates increase, the value of existing bonds decreases. Since the bond purchased is a zero-coupon bond, there are no coupon payments to offset the decrease in value. The calculation to estimate the new value is:

New Value = Face Value / (1 + Prevailing Interest Rate)^Number of Years

Using this formula, the new value would be approximately $475.95, which is closest to option A.

You Purchased a Zero-Coupon Bond Last Week for $499