You chose A

You have bought a 10-year bond with a 10% yield.  The next day interest rates move to 15%.  You will still receive £10k per year.  But the value of your bond has dropped significantly.

£100k would now buy you £15k per year with £100k payment at the end.

You clearly do not need as much as £100k to generate £10k a year with 15% interest rates.
In fact, to buy this same stream of “£10k per year and £100k at the end” would only cost you £75k.

For the more mathematically minded, you simply calculate the Present Value (PV) of all the cashflows using 15% as the discount rate. (bond maths is really not very hard).

Context – You were holding the funds for your gang as the proceeds for a drug deal being completed later today.  When you turn up with only £75k rather than £100k your associates are going to kill you.  Painfully.

If you had been lucky and rates had fallen to 5% instead, then you would have handed over the £100k and kept a tidy profit of £39k for yourself.  Was it worth the risk?

You really should have managed your risk better.

Would you like to change your vote to answer B?  if so click here.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: