This morning, Marty bought a 4% coupon bond at par value. The bond pays semi-annual interest and has twenty years to maturity. By what percentage will the price of Marty's bond change if market interest rates rise by 1.5% tonight?

Question

Quizplus · Accepted Answer

The price of a bond moves inversely to changes in interest rates. If interest rates rise, the price of existing bonds falls because new bonds are issued at the higher rate, making the older, lower-yielding bonds less attractive. The percentage change in a bond's price for a given change in yields is measured by its duration. For a 20-year bond with semi-annual payments and a 4% coupon, the duration will be less than 20 years but still significant, indicating a substantial sensitivity to interest rate changes. A 1.5% increase in market interest rates would significantly decrease the bond's price, and given the options, a decrease of -18.06% is plausible for a long-duration bond like the one described.

This Morning, Marty Bought a 4% Coupon Bond at Par