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In: Finance

If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value


If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value



A 1-year zero coupon bond.


A 1-year bond with an 8% coupon.


A 10-year bond with an 8% coupon.


A 10-year bond with a 12% coupon.


A 10-year zero coupon bond.

Solutions

Expert Solution

Duration of bond measures the sensitivity in price of bond with respect to change in interest rates.

Higher the time of maturity of bond, higher the duration of bond. Therefore 10 year bond have higher duration than 1 year bond.

Lower the coupon payment of bond, higher the duration of bond. Therefore zero coupon bond have higher duration compared to coupon paying bond.

Therefore of the above listed bonds, 10 year zero coupon bond will have highest duration and thus highest sensitivity in price with respect to changes in interest rates.

Therefore, when yield to maturity fall by 1%, a 10-year zero coupon bond would have the largest percentage increase in value.

Therefore last option is correct.

jeff jeffy answered 2 years ago
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