After purchasing a zero-coupon bond for $945 (its face value is $1,000), news arrives that interest rates on savings accounts at banks have risen to 7 percent. What will happen to the price of this bond?

Question

Quizplus · Accepted Answer

When interest rates rise, the value of existing bonds decreases. This is because new bonds issued have higher yields, making older bonds with lower yields less attractive to investors. As a zero-coupon bond, it does not have any interest payments and therefore is more sensitive to changes in interest rates. The bond price will decrease by an amount equal to the difference between the face value and the present value discounted at the new interest rate. Using the formula PV = FV / (1 + r)^n, where r is the new interest rate and n is the number of years until maturity (assumed to be one in this case), the present value of the bond is $879.58. Thus, the difference between the purchase price and the new present value is $945 - $879.58 = $65.42, which is a decrease in price. However, since the question is asking for the change in price, we need to take the opposite sign of this value, which is -$65.42 or -$10.42 rounded to the nearest cent.

After Purchasing a Zero-Coupon Bond for $945 (Its Face Value