Bond Valuation and
Interest Rate Risk The Garraty Company has two bond issues outstanding. Both bonds pay $100 annual
interest plus $1,000 at maturity. Bond L has a maturity of15 years, and Bond S has a
maturity of 1 year.
a. What will be the value of each of these bonds when the going rate of interest is
(1) 5%, (2) 8%, and (3) 12%? Assume that there is only one more interest pay-
ment to be made on Bond S.
b. Why does the longer-term (15-year) bond fluctuate more when interest rates
change than does the shorter-term bond (1 year)?
Yield to Maturity and
Required Returns The Brownstone Corporation’s bonds have 5 years remaining to maturity. Inter-
est is paid annually, the bonds have a $1,000 par value, and the coupon interest
rate is 9%.
a. What is the yield to maturity at a current market price of(1) $829 or (2) $1,104?
b. Would you pay $829 for one of these bonds if you thought that the appropriate
rate of interest was 12%—that is, if rd = 12%? Explain your answer.
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