Which of the following sentences is FALSE? Select one: a. Interest rate risk is the risk...

Which of the following sentences is FALSE?

Select one:

a. Interest rate risk is the risk that results from the changes in interest rates and thereby impact the bond value.

b. As a bond approaches maturity, the price of the bond will approach its par value until, the bond is worth its face value at maturity.

c. The value of a bond that pays semiannual interest is greater than that of an otherwise equivalent annual coupon interest paying bond.

d. The longer the maturity of a Treasury security, the smaller the interest rate risk.

Solutions

Expert Solution

Interest rate risk is one of the major risks while investing in bonds. The price of the bond is equal to the present value of future coupon payments and present value of payment at maturity (face value).

a. is not the asnwer as it is true. Interest rates affect the bond value to a large extent. When interest rates rise, the price of the bond falls and vice versa.

b. is not the answer as it is true. Because of time value of money, the bond price is lower than face value before maturity. But as it approaches maturity, its price increases and approaches the par value.

c. is not the answer as it is true. Bonds which pay semi- annual coupon payments have value higher than otherwise annaul coupon paying bond due to time value of money. If coupon payments are 8% on $1000 face value and payment is semi-annual, then 40 is received in 6 months itself and 40 in a year's time, whereas in annual paying, 80 is received at the end. In the first case, that 40 can be invested to earn more.

d. is the answer as it is false. When maturity is longer, then potential of volatility in interest rates is higher. Thus, the higher would be the interest rate risk. For short duration, interest rate risk is less.

jeff jeffy answered 1 year ago

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