Company A has two 7% coupon bonds outstanding.Each of the bonds pays interest annually.Bond A has 5 years to maturity and bond B has 10 years to maturity.The current market rate of return is 6%.What will happen if the market rate of return decreases to 5%?

Question

Quizplus · Accepted Answer

When the market rate of return decreases to 5%, the price of both bonds will increase as their coupon rate is higher than the market rate. However, bond A, with a shorter time to maturity, will experience a greater percentage change in price than bond B, which has a longer time to maturity. This is because bond A's cash flows will be paid back sooner, and its price will be more sensitive to changes in interest rates. Therefore, the percentage change in the price of bond A will be less than that of bond B.

Company a Has Two 7% Coupon Bonds Outstanding