Suppose you are considering the purchase of a bond with five

Suppose you are considering the purchase of a bond with five years remaining to maturity. The bond has a face amount of $1,000, a coupon interest rate of 4.5%, pays interest annually. The yield to maturity on this bond is currently 3%. If interest rates decrease by 1 percentage point (100 basis points), how much will the bond’s value change?

Solution

Face Amount (P)= $1000.

Interest Rate (R) = 4.5%

Time(T) = 5

Simple Interest (S.I.) = (P*T*R)/100

=> S.I.=(1000*4.5*5)/100

=> S.I. = 225.

Therefore total amount after 5 years maturity (A) = P + S.I.= $1000 +$225 = $1225.

Suppose, the interest rate is decreased by1%.    i.e. R= 3.5%

So, new S.I. = $175.

new amount will be A = $1175.

Therefore, the bond\'s value change depending on the variation of interest rates = $1225 - $1175 = $50(answer).