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Homework answers / question archive / What are the cash flows associated with calculating the present value of bonds? What happens to the value of bonds when interest rates increase? Explain why this happens? What happens to the value of bonds when interest rates decrease? Explain why this happens? What impact does the number of years until maturity have on the value of a bond? (include references) Example: a 5 year to maturity bond has a coupon of 7% and is trading at par

What are the cash flows associated with calculating the present value of bonds? What happens to the value of bonds when interest rates increase? Explain why this happens? What happens to the value of bonds when interest rates decrease? Explain why this happens? What impact does the number of years until maturity have on the value of a bond? (include references) Example: a 5 year to maturity bond has a coupon of 7% and is trading at par

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What are the cash flows associated with calculating the present value of bonds? What happens to the value of bonds when interest rates increase? Explain why this happens? What happens to the value of bonds when interest rates decrease? Explain why this happens? What impact does the number of years until maturity have on the value of a bond? (include references)

Example: a 5 year to maturity bond has a coupon of 7% and is trading at par. What will happen to the bond if the rates on similar bonds increase by 100 basis points?

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What are the cash flows associated with calculating the present value of bonds? What happens to the value of bonds when interest rates increase? Explain why this happens? What happens to the value of bonds when interest rates decrease? Explain why this happens? What impact does the number of years until maturity have on the value of a bond? (include references)

Example: a 5 year to maturity bond has a coupon of 7% and is trading at par. What will happen to the bond if the rates on similar bonds increase by 100 basis points?

In order to calculate the present value of bonds, we will need to use the present value of the dollars of interest paid each year and the present value of the maturity value of the bond paid at the end of the period. However, if the interest rate in the market increases, the bond will be sold at a discount or below par value. This is due to the fact that the investor can buy new bonds issued at the higher interest rate and not willing to pay the same amount of money to invest in bonds that pay lesser.

On the other hand, if the interest rates decrease, the bond will be sold at a premium or above par value. The investors would prefer to buy the bonds that provide higher coupon rates and willing to pay higher to obtain its higher coupons.

The number of years until maturity have impact on the value of a bond because the interest rates in the market fluctuate every day. The value of the bond will also fluctuate accordingly. As a result, the longer the number of years, the higher fluctuation in the value of the bond.

Example: a 5 year to maturity bond has a coupon of 7% and is trading at par. What will happen to the bond if the rates on similar bonds increase by 100 basis points?

The increase of 100 basis points means the increase of rate by 1%.

We can find the new value for the bond by replacing the new rate into the formula.

B = 70 x [1 - 1/(1 + 0.08)5] + 1,000/(1 + 0.08)5
0.08

B = 70 x 3.9927 + 1,000 x 0.6806
B = 960.09

The value of the bond will be decreased.

Brigham, Eugene F., Gapenski, Louis C., and Ehrhardt, Michael C. (1999). Financial Management. The Dryden Press (9th Edition).

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