Question

True or false:

1. If interest rates fall by 1%, a 10-year, 3% coupon bond will increase in percentage of price less than an otherwise equivalent zero-coupon bond.

2. The term structure of interest rates defines the relation between bond maturity and bond yield to maturity.

3. Nominal interest rates tend to increase when the economy expands.

4. A pension fund would probably prefer a municipal security with a yield of 2.5% to an equivalent corporate bond with a yield of 3%.

Answer 1

1)let us take an example and work out
face value=1000 ytm=3% coupon=3% time=10 years
price of bond=1000
equivalent zero coupon bond price=1000/(1+3%)^10=744.09
now the YTM is reduced by 1% so it is 2%
use pv formuale in excel to find price of bond
coupon bond=pv(2%,10,(3%*1000),1000,0)=1089.93
zero coupon bond=pv(2%,10,(0%*1000),1000,0)=820.35
% change in coupon=(1089.93/1000)-1=8.98%
% change in zero coupon=(820.35/744.09)-1=10.25%
True

2)True and it is the definition

3)True as economy expands inflation also increases and nominal interest rate also increases
Nominal interest=Real interest+inflation

4)False since for pension fund there is no taxes so they will prefer higher yield funds only