Rank the interest sensitivity of the following from the most sensitive to an interest rate change to the least sensitive:
I. 8% coupon, noncallable 20-year maturity par bond
II. 9% coupon, currently callable 20-year maturity premium bond
III. Zero-coupon 30-year maturity bond
A) I, II, III
B) II, III, I
C) III, I, II
D) III, II, I

Question

Quizplus · Accepted Answer

Zero-coupon bonds (such as III) have the highest interest rate sensitivity because they do not pay any coupons, which means that their prices are entirely dependent on the interest rates. Noncallable bonds (like I) have medium sensitivity because they cannot be called before the maturity; thus, investors will hold them for a more extended period. Callable bonds (like II) have the least interest rate sensitivity because of the possibility of the issuer "calling" them, which limits the potential price appreciation. As a result, the order is III, I, II. Therefore, we choose choice C as the answer.

Rank the Interest Sensitivity of the Following from the Most