( Interest rate risk ) Two years ago your corporate treasurer purchased, for the firm, a 20-year bond at its par value of $1,000. The coupon rate on this security is 8 percent. Interest payments are made to bondholders once a year. Currently, bonds of this particular risk class are yielding investors 9 percent. A cash shortage has forced you to instruct your treasurer to liquidate the bond. a. At what price will your bond be sold? Assume annual compounding. b. What will be the amount of your gain or loss over the original purchase price? c. What would be the amount of your gain or loss had the treasurer originally purchased a bond with a 4-year rather than a 20-year maturity? (Assume all characteristics of the bonds are identical except their maturity periods.) d. What do we call this type of risk assumed by your corporate treasurer?

Foundations Of Finance

10th Edition

ISBN: 9780134897264

Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William

Publisher: Pearson,

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Chapter 17, Problem 5SP

(Interest rate risk) Two years ago your corporate treasurer purchased, for the firm, a 20-year bond at its par value of $1,000. The coupon rate on this security is 8 percent. Interest payments are made to bondholders once a year. Currently, bonds of this particular risk class are yielding investors 9 percent. A cash shortage has forced you to instruct your treasurer to liquidate the bond.

a. At what price will your bond be sold? Assume annual compounding.
b. What will be the amount of your gain or loss over the original purchase price?
c. What would be the amount of your gain or loss had the treasurer originally purchased a bond with a 4-year rather than a 20-year maturity? (Assume all characteristics of the bonds are identical except their maturity periods.)
d. What do we call this type of risk assumed by your corporate treasurer?

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Chapter 17, Problem 3SP

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Solution Summary: The author explains how to determine the price at which the bonds are to be sold, the loss over the original purchase price, and the type of risk associated with interest rate risk.

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