Reference no: EM133071640

Bond Valuation and Risk

1. How Interest Rates Affect Bond Prices. Explain the impact of a decline in interest rates on:

a. An investor's required rate of return.

b. The present value of existing bonds.

c. The prices of existing bonds.

2. How would a financial institution with a large bond portfolio be affected by falling interest rates? Would it be affected by a greater degree than a financial institution with a greater concentration of bonds (and fewer short-term securities)? Explain.

3. If a bond's coupon rate is greater than the investor's required rate of return on the bond, would the bond's price be greater than or less than its par value? Explain.

4. Is the price of a long-term bond or the price of a short-term security more sensitive to a change in interest rates? Why?

5. Assume that inflation is expected to decline in the near future. How could this affect future bond prices? Would you recommend that financial institutions increase or decrease their concentration in long-term bonds based on this expectation? Explain.

6. Explain the concept of bond price elasticity. Would bond price elasticity suggest a higher price sensitivity for zero-coupon bonds or high-coupon bonds that are offering the same yield to maturity? Why? What does this suggest about the market value volatility of mutual funds containing zero-coupon Treasury bonds versus high-coupon Treasury bonds?

7. What is duration and how is it determined? Determine how the duration of a bond be affected if the coupons were extended over additional time periods.