Question

Which answer is TRUE regarding bond prices and interest rates?

		Bond prices and interest rates move in opposite directions.
		Interest rate risk is the risk that a company will default on its interest payments.
		The prices of short-term bonds display greater price sensitivity to interest rate changes than do the prices of long-term bonds.
		The price of a bond is the future value of the coupon payment and the face value.

Answer 1

1. Bond prices and interest rates move in opposite direction. This is TRUE. Because when market interest rates drop, the bond in question becomes more valuable as it carries the higher interest compared to other. Hence its price will go up. Similarly when market interest rates increase, the bond in question will become less valuable because the coupon rate on it will not be comparable to market. Why should an investor buy that bond when he can buy others for higher rate of interest? Hence its price will drop.
2. Interest rate risk is the risk that a company will default on its interest payments. This is FALSE. Interest rate risk is the potential of investment losses that result from a change in interest rates. If interest rates rise, for instance, the value of a bond will decline.  
3. The prices of short-term bonds display greater price sensitivity to the interest rate changes than do the prices of long-term bonds. This is FALSE. The higher the duration, the more sensitive the bond or bond fund will be to changes in interest rates because there is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within a long-term period than within a shorter period
4. The price of a bond is the future value of the coupon payment and the face value. This is FALSE. A bond’s price is equal to the present value (and not the future value) of its expected future cash flows.

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