State the directional price change, if any, assuming interest rate volatility increases, for each of…

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CFA Examination Level II

On May 30, 1999, Janice Kerr is considering purchasing one of the following newly issued 10-year AAA corporate bonds shown in the following exhibit. Kerr notes that the yield curve is currently flat and assumes that the yield curve shifts in an instantaneous and parallel manner.

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BOND CHARACTERISTICS
Description Coupon Price Callable Call Price
Sentinel due May 30, 2009 6.00% 100 Noncallable Not applicable
Colina due May 30, 2009 6.20% 100 Currently callable 102

a. Contrast the effect on the price of both bonds if yields decline more than 100 basis points. (No calculation is required).

b. State and explain under which two interest rate forecasts Kerr would prefer the Colina bond over the Sentinel bond.

c. State the directional price change, if any, assuming interest rate volatility increases, for each of the following:

(1) The Sentinel bond

(2) The Colina bond

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