Which of the following statements is most correct?
A) All else equal, an increase in interest rates will have a greater effect on the prices of long-term bonds than it will on the prices of short-term bonds.
B) All else equal, an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds.
C) An increase in interest rates will have a greater effect on a zero coupon bond with 10 years maturity than it will have on a 9-year bond with a 10 percent annual coupon.
D) All of the statements above are correct.
E) Answers a and c are correct.

Question

Quizplus · Accepted Answer

A) All else equal, an increase in interest rates will have a greater effect on the prices of long-term bonds than it will on the prices of short-term bonds. This is because long-term bonds have a greater duration, which measures the sensitivity of a bond's price to changes in interest rates.

C) An increase in interest rates will have a greater effect on a zero coupon bond with 10 years maturity than it will have on a 9-year bond with a 10 percent annual coupon. This is because the zero coupon bond has no coupon payments to offset the impact of rising interest rates, whereas the 9-year bond with a 10 percent annual coupon will continue to pay out a fixed amount each year, reducing the impact of rising rates on its price.

B) This statement is not entirely correct because the effect of interest rate changes on higher-coupon bonds versus lower-coupon bonds depends on the specific circumstances of the bonds in question. In general, higher-coupon bonds are less sensitive to interest rate changes than lower-coupon bonds because they have a higher component of current income. However, if interest rates rise significantly, higher-coupon bonds may still experience greater price declines than lower-coupon bonds due to their longer duration.

Therefore, the most correct statement is E.

Which of the Following Statements Is Most Correct