Question

ssuming all else is constant, which of the following statements is CORRECT? a. A 20-year zero coupon bond has more reinvestment rate risk than a 20-year coupon bond. b. For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate. c. From a corporate borrower's point of view, interest paid on bonds is not tax-deductible. d. For any given maturity, a 1.0 percentage point decrease in the market interest rate would cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage point increase in the interest rate. e. Price sensitivity as measured by the percentage change in price due to a given change in the required rate of return decreases as a bond's maturity increases.

Answer 1

Answer: b. For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate

Explanation:

This is very true. If market rates reduce by 1.0%, there is a larger drop in the price of a bond than the amount a bond gains in price if interest rates increase by that same 1.0%.

This is why the graph that relates bond prices to yield is concave and I attached a graph as proof.

Notice how the fall in price is greater when interest rate increases.