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) a 1-year bond with a 15% coupon.
B) a 3-year bond with a 10% coupon.
C) a 10-year zero coupon bond.
D) a 10-year bond with a 10% coupon.
E) an 8-year bond with a 9% coupon.

Question

Quizplus · Accepted Answer

The bond with the longest duration will experience the largest percentage increase in price for an interest rate decrease. A zero coupon bond has the longest duration among the given options since it does not make any coupon payments and its entire return is dependent on the final redemption value. Therefore, option C, the 10-year zero coupon bond, would have the largest percentage increase in price when interest rates decline.

Assume That All Interest Rates in the Economy Decline from 10