Assume that you buy a $1,000 par value bond at a premium and that it matures in
ID: 2371640 • Letter: A
Question
Assume that you buy a $1,000 par value bond at a premium and that it matures in 10 years.
a. What would you expect the value of the bond to do if the interest that investors were willing to accept on the bond did not change from the day you purchased it to maturity?
b. Why would the interest payments have a greater impact on the value of the bond initially and the maturity value have a greater impact on the value of the bond as it gets closer to the maturity date?
c. Approximately what would the value of the bond be one day before the maturity date, assuming that there is no expectation of default?
Explanation / Answer
a. If Int rate doesn't change, The Value of Bond will increase, so at Maturity, Premium amount is paid.
Eg. If Bond FV is $1000 & Premium is $100, Then bond value will gradually increase from 1000 to 1100 on maturity
b. Int Payment will have greater impact initally as the buyer has paid more than face value (Premium).So is return by way of Int is still on Face value & hence have greater impact.
Maturity value has greater impact as Bnd gets closure to maturity because maturity is at a premium to face value
c. Bond value before one day will be close to Bond Face value + prem paid. SO if we assume above values, it will be close to $1100.