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Chapter 5: 9DQ (page 524)

Discuss the relationship between bond prices and interest rates. What impact do changing interest rates have on the price of long-term bonds versus short-term bonds? (LO16-2)

Short Answer

Expert verified

The bond prices and interest rates have an inverse relationship. When prices of bonds increase, the interest rates go down.

Step by step solution

01

Bonds

The term bond refers to a fixed-incomefinancial instrument representing the money invested by an investor in a corporation for generating interest income and the principal amount.

02

Relationship between interest rates and bond prices

The interest rates and bonds prices move precisely in the opposite directions. If interest rates go up in the market, then the prices of a bond will go down.

The long-term bonds are impacted more because of interest rate variations in the market. Short-term bonds鈥� maturity date is closer thanlong-term debts.

Long-term debts are more sensitive to interest rate changes because they contain a longer duration than short-term bonds.

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Question:Cox Media Corporation pays an 11 percent coupon rate on debentures that are due in 10 years. The current yield to maturity on bonds of similar risk is 8 percent. The bonds are currently callable at $1,110. The theoretical value of the bonds will be equal to the present value of the expected cash flow from the bonds.

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