Response: We use a present value table to look up the value of the $1000 principal to be paid 8 years or 16 semi-annual periods. Looking at the 3% row (rate per semi-annual period), we find the factor of .623. Multiplying by $1000, the investor is selling the value of the principal for $623.00. Using a present value of an annuity table, we also look up R=3% and N=16 to find the factor 12.561. Multiplying 12.561 times the $40 semi-annual coupon, we find our investor is selling the remaining stream of 16 coupon payments for $502.44. Thus the price of the bond is $623.00 + $502.44 = $1,125.44. But the bond originally cost our investor $1,000, so the capital gain is 125.44 (using financial calculator, the answer is $125.61). Section: Measuring Bond Yields.
-What happens to the price of bonds, if interest rates go up?
A) The price of bonds goes up.
B) The price of bonds stays the same.
C) The price of bonds goes down.
D) The relationship between interest rates and bond prices cannot be determined.

Question

Response:  We use a present value table to look up the value of the $1000 principal to be paid 8 years or 16 semi-annual periods.  Looking at the 3% row (rate per semi-annual period), we find the factor of .623.  Multiplying by $1000, the investor is selling the value of the principal for $623.00.  Using a present value of an annuity table, we also look up R=3% and N=16 to find the factor 12.561.  Multiplying 12.561 times the $40 semi-annual coupon, we find our investor is selling the remaining stream of 16 coupon payments for $502.44.  Thus the price of the bond is $623.00 + $502.44 = $1,125.44.  But the bond originally cost our investor $1,000, so the capital gain is 125.44 (using financial calculator, the answer is $125.61). Section: Measuring Bond Yields.
-What happens to the price of bonds, if interest rates go up? 
A) The price of bonds goes up.
B) The price of bonds stays the same.
C) The price of bonds goes down.
D) The relationship between interest rates and bond prices cannot be determined.

Quizplus · Accepted Answer

When interest rates go up, new bonds will offer higher yields than the older ones with lower rates. This makes the bonds with lower rates less attractive to investors, causing a decrease in demand and thus a decrease in their price.

Response: We Use a Present Value Table to Look