Bonds and their valuation (Difficulty: e = Easy, m = Medium, and t = Tough) Multiple Choice: Conceptual

Statement c is correct; the other statements are false. Zero coupon bonds have greater price risk than either of the coupon bonds or the annuity.

Statement c is correct; the other statements are false. All other things equal, a zero coupon bond will experience a larger percentage change in value for a given change in interest rates than will a coupon-bearing bond. Further, bonds with long remaining lives experience greater percentage changes in value than do bonds with short remaining lives. Thus, of the bonds listed, the 10-year zero coupon bond has the largest percentage increase in value.

Statement a is correct. All other things equal, a zero coupon bond will experience a larger percentage change in value for a given change in interest rates than will a coupon-bearing bond. Further, bonds with long remaining lives experience greater percentage changes in value than do bonds with short remaining lives. Thus, of the bonds listed, the 10-year zero coupon bond has the largest percentage increase in value.

Statement a is correct. The longer the maturity and the lower the coupon of a bond, the more sensitive it is to interest rate (price) risk. The bond in answer a has a maturity greater than or equal to and a coupon less than or equal to all the other bonds.

Statement a is correct. The bond with the smallest coupon and longest maturity will be most sensitive to changes in interest rates.

The correct answer is e; the other statements are false. A zero coupon bond will always sell at a discount below par, provided interest rates are above zero, which they always are.