Rank the following bonds, from highest to lowest interest rate risk: 2-year zero coupon, 2-year 5% coupon bond, 30-year 5% coupon bond, 30-year, zero coupon bond.
A) 30-year, zero coupon bond, 30-year 5% coupon bond, 2-year 5% coupon bond, 2-year zero coupon bond
B) 2-year 5% coupon bond, 2-year zero coupon bond, 30-year 5% coupon bond, 30-year zero coupon bond
C) 30-year, zero coupon bond, 30-year 5% coupon bond, 2-year zero coupon bond, 2-year 5% coupon bond
D) 30-year, 5% coupon bond, 30-year zero coupon bond, 2-year 5% coupon bond, 2-year zero coupon bond

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Quizplus · Accepted Answer

Zero coupon bonds have the highest interest rate risk because there is no coupon payment to buffer the effect of changes in interest rates. Therefore, the 30-year zero coupon bond is the riskiest followed by the 2-year zero coupon bond. Among the coupon bonds, the longer-term bond has greater interest rate risk because it is exposed to changes in interest rates for a longer period of time. Therefore, the ranking would be 30-year 5% coupon bond, followed by 2-year 5% coupon bond. Putting these together, the ranking from highest to lowest interest rate risk is: 30-year zero coupon bond, 2-year zero coupon bond, 30-year 5% coupon bond, 2-year 5% coupon bond. This matches choice C.

Rank the Following Bonds, from Highest to Lowest Interest Rate