Question

Which of the following statements is CORRECT? a. Long-term bonds have less price risk but more reinvestment risk than short-term bonds. b. Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more price risk but less reinvestment risk. c. If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less price risk. d. Long-term bonds have less price risk and also less reinvestment risk than short-term bonds. e. One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.

Answer 1

Answer:

B) Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more price risk but less reinvestment risk.

Explanation:

Price risk refers to the risk associated with changing bond prices as the interest rates fluctuate. Higher interest rates = lower bond prices.

Reinvestment risk refers to the risk that the cash flows generated by bonds fluctuates due to changes in the interest rates. For example, if the interest rate decreases, the investor will not be able to reinvest the proceeds from the coupons at the same interest rate than the bond itself.

A zero coupon bond practically eliminates reinvestment risk, but is very sensitive to price risk.