Question

Two 10 year bonds with a 5% YTM experience a sudden increase to 6% YTM.  Bond A is a zero coupon bond -- a bond which pays no coupon -- while Bond B is a 5% coupon bond.  Which bond experiences a larger percentage change in price?  Why?

Answer 1

An Increase in YTM from 5% to 6% will cause an decrease in Price of both the Bonds as when YTM increases the Price of Bond decrease due to the Inverse realtionship that exists between YTm and Bond' sprice.

Bond A is a zero coupon Bond and Bond B is 5% coupon bond both having 10 years to maturity.

- The percentage of change in Price of Bond A a Zero coupon Bond will be higher than that of Bond B which is 5% coupon Bond due to the fact that when YTM increases or decreases the flactuation in price of Zero- Coupon Bond is higher than other Bond because zero Coupon Bond does not pay periodic Interest or Coupon payments.

- Zero Coupon Bond does not pay periodic Interest or Coupon payments and to compensate that they are issued at deep discount and when YTM flactuates the chnage in Price is significant as compared to others bond due to Coupon payments as the fixed Income is not available