Consider Two Bonds, a and B

question 22

Multiple Choice

Consider two bonds, A and B. Both bonds presently are selling at their par value of $1 000. Each pay interest of $120 annually. Bond A will mature in 5 years while Bond B will mature in 6 years. If the yields to maturity on the two bonds change from 12% to 14%, ________.

• A)both bonds will increase in value but Bond A will increase more than Bond B
• B)both bonds will increase in value but Bond B will increase more than Bond A
• C)both bonds will decrease in value but Bond A will decrease more than Bond B
• D)both bonds will decrease in value but Bond B will decrease more than Bond A

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Definitions:

Capital Asset Pricing Model

The Capital Asset Pricing Model (CAPM) is a formula used to determine the expected return on an investment based on its risk relative to the market.

Abandonment Option

A provision in a contract that allows a party to withdraw from the contract before the completion or maturity date.

Monte Carlo Simulation

A computational technique that uses random sampling and statistical modeling to estimate mathematical functions and mimic the operation of complex systems.

Probability Distributions

Probability distributions describe the likelihood of different outcomes in a stochastic process or experiment.