Question

Suppose it is ‘breaking news’ that interest rates will fall by a fixed amount for the...

Suppose it is ‘breaking news’ that interest rates will fall by a fixed amount for the indefinite future. Prices for a 10-year bond will _________ by _________ than prices for a 2-year bond.

a. rise, less

b. rise, more

c. fall, less

d. fall, more

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Answer #1

Solution:

Answer-  b. rise, more

Explanation- The relation between interest rat and bond price is vice-versa. So, if interest rates fall the bond price will rise and if interest rates rise, bond price will fall. In this case interest rates fall, that means bond rate will rise. And we also know that the long maturity bond is more sensitive to change in the interest rates. So, for 10-year bond the price change will be more than for a 2-year bond. Therefore, suppose it is ‘breaking news’ that interest rates will fall by a fixed amount for the indefinite future. Prices for a 10-year bond will rise by more than prices for a 2-year bond.

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