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Unformatted text preview: they are 7%. Lower interest rates mean higher bond prices. This is true by the formula connecting P and r, meaning it is true by definition. 5) A decline in interest rates from 10% (.1000) to 7% (.0700) drives up the price of a 10 year zero from $385.54 to $508.35an increase of 31.85%. This is an enormous jump in the price of a bond. This occurs because the drop in rates is enormousequal to 300 basis point. A basis point is equal to .0001, or one hundredth of one percent, and the drop from .1000 to .0700 is .0300 (3% or 300 basis points). Interest rates on ten year bonds in the U.S. change by 5 or 10 basis points per day, while over a year they may vary by 100 or 200 basis points. 6) Compare the 31.85% price increase on the 10-year zero from (5) with the percentage price change of the 3-year zero when rates drop from 10% to 7%. The price of the 3-year zero increases by 8.65%. The lesson: longer maturity zeros have greater percentage price volatility than shorter maturity zeros for the same change in interest rates....
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- Spring '08