A corporate bond with an 8.5% coupon has 10 years left to maturity. It has had a credit rating of A and a yield to maturity of 10%. The firm has recently gotten into some trouble and the rating agency is downgrading the bonds to BBB. The new appropriate discount rate will be 11.5%. What will be the change in the bond's price in dollars? Assume interest payments are paid semi-annually and par value is $1,000.

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Quizplus · Accepted Answer

The correct answer is A because the price of the bond will decrease as the yield to maturity increases. The change in the bond's price can be calculated using the following formula:Change in bond price = (PV1 - PV2)where:PV1 is the present value of the bond at the old yield to maturityPV2 is the present value of the bond at the new yield to maturityThe present value of the bond can be calculated using the following formula:PV = C * [1 - (1 + r)^-n] / rwhere:C is the coupon paymentr is the yield to maturityn is the number of years to maturityUsing the given information, we can calculate the present value of the bond at the old yield to maturity as follows:PV1 = 42.5 * [1 - (1 + 0.1)^-20] / 0.1 = 698.52We can then calculate the present value of the bond at the new yield to maturity as follows:PV2 = 42.5 * [1 - (1 + 0.115)^-20] / 0.115 = 616.39The change in the bond's price is therefore:Change in bond price = 698.52 - 616.39 = -$82.13

A Corporate Bond with an 8