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Calculate the price of the bond A-B-C-D, continuously compounding
Calculate the price of the bond A-B-C-D, continuously compounding. Year to Settlement Bond name Coupon rate A 0.04 B 0.08 ? 0.04 0.08 5 5 20 20 Compare these bonds' price changes when yield changes 0.1%, 0.5%, 1% both positively and negatively. Examine the bonds price sensitivity to coupon rate and maturity.
Expert Solution
Assuming Par Value of all bonds to be 1000
Assuming Initial YTM on Bonds to be 5%
Continuous Compounding
Present Value = Future Value / e^(r*t)
At Initial Rate
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We examine that an increase in yield has a negative impact on price of bond. The higher the increase in yield, the price decreases by a larger amount.
An increase of 0.1% in yield reduces the price but much less than a 1% increase in yield. Similarly, 1% decrease in yield increases the price more than a .1% decrease in yield.
As the coupon rate increases, the present value of bonds (price) increases . This is because the amount of coupon payments on the bond increases which makes the bond more valuable.
As the maturity period increases, the number of coupon payments increases which increases the price of the bond. This only occurs if coupon rate is greater than rate of yield. If yield is greater than coupon rate , then increase in maturity reduces the present value of bond.
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