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The yield rises by 2%. Which bond will have a greater percentage change in price: a)...

The yield rises by 2%. Which bond will have a greater percentage change in price: a) A 16-year, zero coupon bond? b) A 2-year, 7% coupon bond? c) A 5-year, 4% coupon bond?

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Answer #1

Answer: A 16-year, zero coupon bond

Bond which has higher duration witnesses higher percentage change in price of bond. Duration of the bond is directly proportional to number of years to maturity and  inversely proportional to coupon rate on the bond.

In this case, years to maturity is highest for bond in option A, and at the same time, the same bond has lowest coupon rate. This implies it would have highest duration and hence, highest sensitivity to change in interest rates.

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