Question

which one of the following bonds is most sensitive to changes in market interest rates?

A. 6% annual coupon for 4 yrs

B. 0% coupon for 4 yrs

C. 8% annual coupon for 4 yrs

D. 0% coupon for 10 yrs

E. 6% annual coupon for 10 yrs

Answer 1

D is the right option

The higher the maturity of the bond, higher is its volatility and sensitivity to interest rates. This is because there is a greater probability that interest rates will increase during the longer period thus pulling down the prices. Hence the bond with 10 year maturity will be more subject to changes.

Lower the coupon higher will be the sensitivity to changes. This is because the investors will prefer other bonds over this one when interest rates increase.