Question

All else the same, the price sensitivity of a larger coupon bond to change in interest rate is ___ that of a smaller coupon bond.

A. either greater than or the same as

B. smaller than

C. the same as

D. greater than

Answer 1

Lets understand the relationship between coupon and the interest rate risk: All else the same, a bond with lower coupon has higher interest rate risk because in such case most of the purchase price of the bond is recovered at the time of maturity when the par value is paid off and at each coupon period, only a small portion is recovered. This implies that as larger amount is subjected to the risk of interest rate movements, the bonds with lower coupon has higher interest rate risk as compared to the bond with higher coupon rate and same maturity.

High coupon rate bond has higher cash flows leading to greater recovery of purchase price in the initial periods. Therefore a zero-coupon bond has highest interest rate risk

Having understood this analysis, we can say that: All else the same, the price sensitivity of a larger coupon bond to change in interest rate is Smaller than that of a smaller coupon bond. So B is the correct option