Corporate Financial Management (B16)
(Interest rate risk) Philadelphia Electric has many bonds trading on the New York Stock
Exchange. Suppose PhilEl s bonds have identical coupon rates of 9.125% but that one issue
matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment
was made yesterday.
a. If the yield to maturity for all three bonds is 8%, what is the fair price of each bond?
b. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%.
What is the fair price of each bond now?
c. Suppose that the yield to maturity for all of these bonds changed instantaneously again,
this time to 9%. Now what is the fair price of each bond?
d. Based on the fair prices at the various yields to maturity, is interest rate risk the same,
higher, or lower for longer versus shorter maturity bonds?