Question

Both Bond Sam and Bond Dave have 9 percent coupons, make semiannual payments, and are priced at par value. Bond Sam has 5 years to maturity, whereas Bond Dave has 15 years to maturity. If interest rates suddenly rise by 3 percent, what is the percentage change in the price of Bond Sam?

Answer 1

As Bond Sam has a shorter maturity and thus higher duration, its price might drop approximately 13.5% (approx. 4.5% per 1% change in yield, given its 3% yield increase).

How to solve

The price of a bond moves inversely to changes in interest rates. With a 3% increase in interest rates, the price of Bond Sam, having a shorter maturity of 5 years, is expected to decrease more than Bond Dave's price.

Using the modified duration formula (approximate percentage change in price = -duration × change in yield), the percentage change in Bond Sam's price can be estimated.

As Bond Sam has a shorter maturity and thus higher duration, its price might drop approximately 13.5% (approx. 4.5% per 1% change in yield, given its 3% yield increase).