Question

10. Long-term Treasury bonds currently are selling at yields to maturity of nearly 6%. You expect interest rates to fall. The rest of the market thinks that they will remain unchanged over the coming year. In each question, choose the bond that will provide the higher holding-period return over the next year if you are correct. Briefly explain your answer. a. i.A Baa-rated bond with coupon rate 6% and time to maturity 20 years. i. An Aaa-rated bond with coupon rate of 6% and time to maturity 20 years. i. An A-rated bond with coupon rate 3% and maturity 20 years, callable at 105. b. ii. An A-rated bond with coupon rate 6% and maturity 20 years. callable at 105 c. i. A 4% coupon noncallable T-bond with maturity 20 years and YTM 6% i. A 7% coupon noncallable T-bond with maturity 20 years and YTM 6%

Answer 1

If rates fall, price of bonds rise
Price of bonds rise the most for high duration bonds

Higher maturity means higher duration

1.
Lower yield to maturity means higher duration
Baa rated bond has lower maturity so select Baa rated bond

2.
Lower coupon rate means higher duration
A rated bond with coupon rate 3%

3.
Lower coupon rate means higher duration
A 4% coupon noncallable T-bond