Reading 64: Introduction to the Valuation of Debt Securities change, expected, discount, face, 2010

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LOS d: Explain how the price of a bond changes as the bond approaches its maturity date and compute the change in value that is attributable to the passage of time.

If a bond sells at a discount and market rates are expected to stay the same until maturity, the price of the bond will:

A) increase over time, approaching the par value minus the final interest payment at maturity.

B) remain constant until maturity.

C) increase over time, approaching the par value at maturity.

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The bond’s price will increase towards the par value over time.

 

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Consider a bond that pays an annual coupon of 5% and that has three years remaining until maturity. Assume the term structure of interest rates is flat at 6%. If the term structure of interest rates does not change over the next twelve-month interval, the bond's price change (as a percentage of par) will be closest to:

A) -0.84.

B) 0.00.

C) 0.84.

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The bond price change is computed as follows:

Bond Price Change = New Price ? Old Price = (5/1.06 + 105/1.06²) ? (5/1.06 + 5/1.06² + 105/1.06³) = 98.17 ? 97.33 = 0.84.

The value -0.84 is the correct price change but the sign is wrong. The value 0.00 is incorrect because although the term structure of interest rates does not change the bond price increases since it is selling at a discount relative to par.

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If market rates do not change, as time passes the price of a zero-coupon bond will:

A) approach the purchase price.

B) approach zero.

C) approach par.

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A bond's value may differ substantially from it's maturity value prior to maturity.  But as maturity draws nearer the bond's value converges to it's maturity value.  This statement is true for regular bonds as well as zero-coupon bonds. 

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A discount bond (nothing changes except the passage of time):

A) rises in value as time passes.

B) falls in value as time passes.

C) price is not related to time passing.

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A discount bond sells at less than face value, therefore as time passes the bond value will converge upon the face value.

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An investor buys a 20-year, 10% semi-annual bond for $900. She wants to sell the bond in 6 years when she estimates yields will be 10%. What is the estimate of the future price?

A) $1,000.

B) $1,079.

C) $946.

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Since yields are projected to be 10% and the coupon rate is 10%, we know that the bond will sell at par value.

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A 5-year bond with a 10% coupon has a present yield to maturity of 8%. If interest rates remain constant one year from now, the price of the bond will be:

A) lower.

B) the same.

C) higher.

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A premium bond sells at more than face value, thus as time passes the bond value will converge upon the face value.