Question

Two bonds will mature in 15 years. One pays 8 percent interest and the other is a zero coupon bond. If market interest rate goes up, value of a zero coupon bond (in percent) will _____ than the coupon bond:

a. increase more

b decrease less

c. increase less

d. decrease more

e. none of the above

Answer 1

If the market interest rate goes up, the value of any bond decreases. So, eliminate answer choices that say bond value increases. Eliminate options a, and c

For a given change in market interest rates, lower the coupon rate, higher is the price sensitivity and vice versa. So, zero coupon bonds will decrease in value more than the coupon bond.

Option d is correct.

Option b is incorrect because the zero coupon bond is more price sensitive to the market interest rate changes and hence it decreases in value more than tht decrease in value of the coupon bond.