I have a question that I need answered by bond pricing theory.
Not looking for financial advice here, just the math, with some
real-world data plugged into the formulas.

Assume corporate BBB-rated bonds have a Yield To Maturity of
roughly 3.5% in the 1-year duration, 4.5% in the 5-year,
5.5% in the 10-year, and 5.8% in the 15-year.

Under three different scenarios, what is likely (theoreticaly)
the outcome going to be of buying a 10-year BBB bond today and
then selling it in one year?
The three scenarios are: Interest rates Unchanged, Up 1%, or Down 1%.

Everybody knows that "when interest rates go up bond prices
go down". But what's always neglected in this truism, is that
in the time that it took for interest rates to move, time has
passed, you've collected some coupon payments, and the duration
of your bond has decreased. 

Background... here's some stuff I've already read up on
this but failed to digest into a sensible formula:

Q: Spot Rates and Treasury Bill Problems 
http://answers.google.com/answers/threadview?id=485012

Q: Bond Rates 
http://answers.google.com/answers/threadview?id=502077

Advanced Bond Concepts: Convexity
http://www.investopedia.com/university/advancedbond/advancedbond6.asp

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Request for Question Clarification by omnivorous-ga on 24 Apr 2005 09:41 PDT

Hiyi --

You question assumes that the yield curve remains stable.  Do you
understand the concept of a yield curve -- and why that's important to
the assumption?

"Yield Curve"
http://en.wikipedia.org/wiki/Yield_curve

There are some times when the yield curve has been reversed and
short-term rates HIGHER than the long-term ones.

Best regards,

Omnivorous-GA

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Clarification of Question by hiyi-ga on 24 Apr 2005 11:05 PDT

Yes, I understand there are many other factors that will
impact a real-life investment. But for the purposes of this
exercise, please assume a stable Yield Curve, and ignore
the interaction between economic outlook and credit ratings.
Thanks

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Clarification of Question by hiyi-ga on 29 Apr 2005 07:58 PDT

Thanks for your comment. To make the effect of passage of time
on duration more relevant, please assume a 5-year bond instead
of the 10-year in my initial question.

|Everybody knows that "when interest rates go up bond prices
go down". But what's always neglected in this truism, is that
in the time that it took for interest rates to move, time has
passed, you've collected some coupon payments, and the duration
of your bond has decreased.|

Fine, but with anything other than a very short term bond, the
interest one has received is trivial compared with the change in value
of the bond.

An increase in interest rates from 4% to 5% looks trivial
- but it is a 25% increase in rates
- and the value of the bond will drop by approx 25% (subject to maturity value)

Obviously I am talking about Straights - not FRNs

If bonds are paying well above the market, then they are perceived as 'Junk'