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As a present for doing so well in your finance class, your uncle has offered you...

As a present for doing so well in your finance class, your uncle has offered you a choice: He will give you either a zero coupon long term bond or a short term bond that pays coupon payments. Which would you choose and why (think about risk)?

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Answer #1

A long term maturity bond will have higher interest rate sensitivity and hence higher price flutuations compared to a short term bond. Moreover, the long term bond is this case is a zero coupon bond which does not pay any coupons. On the other hand the short term bond is a coupon paying bond with lower risk of prices to interest rate sensitivity. As such the short term bond has dual advantage of lower price sensitivity and coupon payment. Hence it is advisable to choose the lower risk instrument ie Short term bond that pays coupon payment.

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