03B Fin 301 Interest Rate Risk Ulearn

03B Fin 301 Interest Rate Risk Ulearn - Interest Rate Risk...

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Unformatted text preview: Interest Rate Risk and Inflation This section uses annual coupon bonds to simplify exposition 2 Consider zero coupon bonds X and Y Bond X pays \$4,000 in ten years (TX = 10) Bond Y pays \$2,000 in five years (Ty = 5) The interest rate is 14.87%: P0X = \$4,000/1.148710 = \$1,000.0 P0Y = \$2,000/1.14875 = \$1,000.0 Interest rate drops to 10% What happens to the prices of bonds? Which bond is more sensitive to a change in the interest rate? Why? Example Interest Rate Sensitivity 3 New interest rate is 10%: P0X = \$4,000/1.1010 = \$1,542.2 P0Y = \$2,000/1.105 = \$1,241.8 Now suppose interest rate increases to 20% P0X = \$4,000/1.2010 = \$646.0 P0Y = \$2,000/1.205 = \$803.8 Example Interest Rate Sensitivity 4 Example (Question #3) Consider bonds A and B Coupon rate: rCoupon A = rCoupon B = 10% Annual coupons Maturity in years: TA = 20; TB = 10 Interest rate: 10% Both bonds sell for \$1000 Interest rate drops to 4%...
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This note was uploaded on 11/01/2011 for the course BUSINESS FIN301 taught by Professor Andrew during the Fall '10 term at University of Alberta.

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03B Fin 301 Interest Rate Risk Ulearn - Interest Rate Risk...

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