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Which of the following investments is most affected by changes in the level of interest rates?...

Which of the following investments is most affected by changes in the level of interest rates? Suppose interest rates go up or down by 50 basis points(+/- 0.5%). Rank the investments from most affected (largest change in value) to least affected (smallest change in value).

(a) $1 million invested in short-term Treasury bills.

(b) $1 million invested in STRIPS (zero coupons) maturing in December 2025.

(c) $1 million invested in a Treasury note maturing in December 2025. The note pays a 5.5% coupon.

(d) $1 million invested in a Treasury bond maturing in December 2025. The bond pays a 9.25% coupon.

Solutions

Expert Solution

Ranking of investments from most affected to least affected from change of investments -

Rank 1- $1 million invested in a Treasury bond maturing in December 2025. The bond pays a 9.25% coupon.

Rank 2- $1 million invested in a Treasury note maturing in December 2025. The note pays a 5.5% coupon

Rank 3- $1 million invested in short-term Treasury bills

Rank 4- $1 million invested in STRIPS (zero coupons) maturing in December 2025

Explanation for the ranking

1- Strips are zero coupon rated hence the change in interest rate will not affect the same at all.
2- 1 million invested in short term treasury bills, hence the decrease or increase of rate of interest will affect only for 1 year hence the quantum of affect due to change in interest rate will be less as compared to 5 year long investments.
3- the bond with coupon rate of 9.25% will be affected more by 0.5% change as compared to note with a coupon rate of 5.5%

jeff jeffy answered 2 years ago
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