Assume that all interest rates in the economy decline from 10% to 9%.Which of the following bonds would have the largest percentage increase in price?
A) An 8-year bond with a 9% coupon.
B) A 1-year bond with a 15% coupon.
C) A 3-year bond with a 10% coupon.
D) A 10-year zero coupon bond.
E) A 10-year bond with a 10% coupon.

Question

Quizplus · Accepted Answer

The longest term zero-coupon bond, in this case the 10-year zero-coupon bond, will have the largest percentage increase in price when interest rates decline. This is because zero-coupon bonds pay no interest until maturity and are therefore more sensitive to changes in interest rates. The bond's price is directly linked to the prevailing interest rate, with lower rates resulting in higher bond prices.

Assume That All Interest Rates in the Economy Decline from 10