Why do newly issued US Treasury Securities not have call provisions? View the following two bonds:
Bond 1 is a US Treasury Bond with a 4 percent coupon payment due in 2035. This bond does not have a call provision. The required rate of return on this bond is 4 percent.
Bond 2 is a AAA Corporate Bond. It has a coupon rate of 6 percent also due 2035. This bond does not have a call provision. The required rate of return on this bond is 6 percent.
Both bonds have a face value of $1,000.
- Which bond is more risky? Defend your answer.
- What is the value of each bond?
- Now say that interest rates rise immediately (so the maturity period stays the same) so that the required rate of return on the Treasury bond rises to 6 percent and the required rate of return on the corporate bond rises to 8 percent. Calculate the new prices. Analyze the results.
- Now say that instead of interest rates rising they fell so that so that the required rate of return on the Treasury bond falls to 2 percent and the required rate of return on the corporate bond fell to 4 percent. Analyze the results.
- What difference did you see between the outcomes of question 3 and 4?
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