A bond is issued at a face value of rs.100 and a coupon of 10% p.A. The interest rates in the market have increased subsequently. This bond is likely to quote at:
Answers
The discount rate used is the rate of interest prevailing in the market for bonds of the same risk and maturity. ... A higher coupon means that more cash in the form of interest payments flows to the investor before maturity than is the case with a lower coupon bond.
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Answer: Price of Bond shall decrease. So it shall sell below face value
Explanation: Let's say you issue a bond with 5% coupon at 100 par value. Now interest rates go up to 6%, and people issue bonds with 100 par again. Now why would they buy your bond at 5% yield, if they can have 6% for the same price. So naturally the price of your bond will decrease to reflect this discrepancy. When interest rates go down, your bond is more valuable because it pays higher interest.
Now when you look at duration, the closer to maturity a bond is, the smaller the sensitivity to interest rates. If the bond matures next month, you won't get many coupons, only par value so the whole price isn't affected that much. However if it matures in 6 years, there are plenty of coupons left to be paid, and as such the value of the bond is very sensitive to rates paid on other bonds during this period.