Question

Consider the following bonds: Bond Issuer Time to maturity Coupon rate Coupon frequency

1 US Treasury 3 years 8% Semi-annual

2 US Treasury 5 years 3% Annual

3 US Treasury 5 years Zero N/A

4 US Treasury 5 years 3% Semi-annual

All else being equal, rank the bonds (1,2,3,4) from highest to lowest sensitivity to interest rate changes.

Answer 1

Rank	Bonds
1	US Treasury 5 years Zero N/A
2	US Treasury 5 years 3% Annual
3	US Treasury 5 years 3% Semi-annual
4	US Treasury 3 years 8% Semi-annual

Higher term bond and low coupon rates are more sensitive to interest rate change. Zero coupon bonds are highest on interest rate sensitivity scale.

Rank 1: Bond with higher term plus zero coupon makes its more sensitive

Rank 2: Annual coupon in comparison we have semiannual coupons, higher frequency of coupon makes bond less sensitive than annual coupon

Rank 3: Semi annual coupon but it has more years to mature than rank 3 below

Rank 1: Lower term and highest frequency of coupon and higher coupon rate.