You purchased a $1,000 five percent coupon bond that matures in 10 years. How much would your bond be worth if interest rates fall to 4% the day after you purchase the bond? What would the bond be worth in one year if interest rates fell to 4% at that point?

 ANSWER

 

The price of the bond equals the (Present Value) PV of all future cash flows. This includes the PV of the Face Value plus the PV of all Coupon Payments discounted at the market interest rate (Yield to Maturity – YTM)

 

Coupon Payment = $1,000 × 5% = $50

 If interest rates fall to 4% the day after you purchase the bond

 =

 = $405.545 + $675.564

 = $1,081.11

 If interest rates fell to 4% one year after I purchased the bond:

=

 = $371.767 + $702.587

 = $1,074.35

                         

You purchased a $1,000 five percent coupon bond that matures in 10 years Answer