Interest rate risk and bond price changes Fidelity Music Inc. has an older high-yield bond (i.e., junk bond) issue and a more recent investment grade bond issue, both with $1,000 par values. Fidelity’s high-yield 11% coupon bonds have a YTM of 14% and will mature in nine years. The investment grade bonds have a 9% YTM, mature in 22 years, and pay a 6.5% annual coupon. As a bond investor you would like to evaluate the bond price sensitivity to underlying interest rate fluctuations for both Fidelity Music bond issues.
a. What is the current price of both bonds?
b. What will be the percentage change in bond price for both bonds if the underlying interest rates increase by 2%? Which bond has more price sensitivity to interest rate risk.?
c. Alternatively, what will be the percentage change in bond price for both bonds if the underlying interest rates decrease by 2%? Which bond has more price sensitivity to interest rate risk?
d. What conclusions do you draw from comparing your answers to parts b and c?
e. Would your answers to parts b through c change if both bonds matured in 13 years and paid a 12% annual coupon and, if so, how?