Asked by Maison Kyomi on Apr 26, 2024
Verified
Blackwater Industries just issued 12-year, 7% coupon bonds. Freshwater Enterprises just issued 12-year, 6% coupon bonds. Both bonds sold at par. Which one of the following statements is correct concerning these two bonds?
A) Both bonds will change in price by the same amount should the market rate of interest increase by 5%.
B) The Blackwater bonds will sell at a discount when the market rate is 7%.
C) The Freshwater bonds had a higher current yield than the Blackwater bonds when they were issued.
D) The Freshwater bonds are more interest rate sensitive than are the Blackwater bonds.
E) The Freshwater bonds will sell at a premium when the market rate is 8%.
Coupon Bonds
Debt securities that pay the holder a fixed interest rate (coupon) over a specified period until maturity, at which point the principal amount is repaid.
Interest Rate Sensitive
Refers to investments or financial instruments that are significantly impacted by changes in interest rates.
- Learn the association between interest rates and the pricing of bonds, considering the role of factors such as maturity, coupon rates, and yield to maturity in bond valuation.
- Comprehend the idea of interest rate risk along with the impact of bond characteristics including maturity and coupon rates on a bond's susceptibility to changes in interest rates.
Verified Answer
AA
Andrew AdamsomMay 02, 2024
Final Answer :
D
Explanation :
Given that both bonds have the same maturity but different coupon rates, the bond with the lower coupon rate (Freshwater Enterprises, 6%) is more sensitive to interest rate changes. This is because the present value of its lower coupon payments and principal will be more affected by changes in the discount rate (market interest rate) compared to the bond with the higher coupon rate (Blackwater Industries, 7%).
Learning Objectives
- Learn the association between interest rates and the pricing of bonds, considering the role of factors such as maturity, coupon rates, and yield to maturity in bond valuation.
- Comprehend the idea of interest rate risk along with the impact of bond characteristics including maturity and coupon rates on a bond's susceptibility to changes in interest rates.