Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5 years until final maturity; and a 9 percent coupon rate (with interest paid semiannually). Interestingly, Old Chicago Brewery has a very similar bond issue outstanding. In fact, every bond feature is the same as for the Red Frog bonds, except that Old Chicago’s bonds mature in exactly 15 years. Now, assume that the market’s nominal annual required rate of return for both bond issues suddenly fell from 9 percent to 8 percent.
a. Which brewery’s bonds would show the greatest price change? Why?
b. At the market’s new, lower required rate of return for these bonds, determine the per bond price for each brewery’s bonds. Which bond’s price increased the most, and by how much?