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Assuming that all bonds have a face value of $1,000 and a yield to maturity of...

Assuming that all bonds have a face value of $1,000 and a yield to maturity of 10%, which of the following bonds will have the highest degree of interest rate risk?

A bond with 8% coupon rate that matures in 20 years.

A bond with 8% coupon rate that matures in 10 years.

It cannot be determined without further information.

A bond with 10% coupon rate that matures in 10 years. A bond with 10% coupon rate that matures in 20 years

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Answer #1

Answer - A bond with 8% coupon rate that matures in 20 years.

Interest rate risk of a bond (or a liability) is represented by duration of the bond. Higher the duration, higher is the sensitivity of bond with change in interest rate. Duration of bond is directly proportional to time to maturity of bond, and inversely proportional to coupon rate of the bond. So, a bond with higher time to maturity or lower coupon rate would have the highest duration and hence greatest interest rate risk.

In the options above, the bond in first statement has lowest coupon rate and highest time to maturity.

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