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.
1.) Which bond is more risky? Defend your answer.
2.) What is the value of each bond?
3.) 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.
4.) 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.
5.) What difference did you see between the outcomes of question 3 and 4?