Question

Please rank the following three bonds based on their interest rate risk: from highest to lowest. Assume all other characteristics of the three bonds are equivalent.

I: 30-year 1% coupon

II: 1-year 2% coupon

III: 30-year 2% coupon

Choose one of the following:

II>I>III

I>II>III

III>II>I

III>I>II

II>III>I

I > III > II

Answer 1

Bond Interest Rate Risk Depends on Duration of Bond :

Duration Depends on the following factor

• Bond Maturity: With Higher Maturity Duration Increases
• Coupon Payment: With Higher Coupon Payment of Same Maturity Duration will be less with bond with higher coupon payments.

So Interest Rate Risk will be least for  

II: 1-year 2% coupon ( Least Maturity)

On 30 Years Bond : Bond having 2% Coupon payment will have less Interest Rate risk.

I: 30-year 1% coupon > III: 30-year 2% coupon

So the correct order will be :

I > III > II (Ans )