bond finance homework

Question

You currently own a 30 year Treasury Bond at 4% interest, paid semiannually. The market interest rates for like securities rose to 5%. Would your bond sell for a premium or a discount? Why? What would the market value of your bond be? Prove your answer by showing your work.

Answer 1

You would sell at a discount.

 

Assume you invested $1000 in the treasury bond

 

Create the cash flow stream of 59 periods of $20 (4% on $1000 semi-annually) and the final payment of $1020 which includes the interest and return of principal.

 

take the present value of this stream at 4% and you will get $1000

 

Now take the present value of the stream at 5% and you will get a value less than $1000.  That would be the value and you can use it to figure out the discount.

 

Hope this helps.

 

Tom