Question

Everything else equal, the __________ the maturity of a bond and the __________ the coupon, the greater the sensitivity of the bond's price to interest rate changes. longer; higher longer; lower shorter; higher shorter; lower

Answer 1

Answer:

Correct option is (b)

Explanation:

Sensitivity of bond prices to changes in interest rate is higher or greater as the maturity of bond is longer and coupon rates are lower.

Yield and bond prices are inversely related. Due to this, The longer the maturity period, tendency of fluctuation in interest rates are more, thereby increasing or decreasing bond prices.

Since coupon rate is dependent on par value of the bond, the lower the coupon rate, longer would be the time taken to receive face value of bond exposing the bond to interest rate fluctuations again. So, prices of lower coupon rate bonds or zero coupon bonds are highly sensitive to interest rate fluctuations.