Question

The prices of low-coupon bonds tend to be less sensitive to a given change in interest rates than high coupon bonds, other things held constant. O O True False There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the bond ratings get lower. O True or False What's TRUE regarding long-term and short-term bonds (assume they have the same par value and coupon rate)? o Long-term bonds have lower interest rate risk. Short-term bonds have higher reinvestment risk. Long-term bonds have higher reinvestment risk. Short-term bonds have higher interest rate risk.

Answer 1

The answers are as follows:

1. The prices of low-coupon bonds tend to be less sensitive to a given change in interest rate than high-coupon bonds, other things held constant is false. Explanationi Let us assume too bonds: Bind A with 6% coupon rate and Bond B with 9% coupon rate. Prevailing Market Interest Rate = 7.5%. Then, Price of Bond A will decrease as its coupon rate is lower than that of prevailing market interest rate. Similarly, on the other hand, Price & Bond B will increase as its coupon rate is higher I than that of prevailing market interest rate. Now, let us assume Prevailing Market Interest Rate = 6% U TE na

Price of Bond A will trade at por with its tace value. Though, bice a Bond B will increase as its coupon rate is higher than that of prevailing market interest rate. Let us now assume : I Prevailing Market Interest Rate = 9% i Price of Bond A will decrease further to a greater extent, but Price a Bond I B will trade at pare with its face value as its coupon rate is equal to that of prevailing market interest rate Le ren. 2. There is an inverse relationship between bonds' quality ratings and their required rates of returen. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the bond ratings get lower is True

Gablanation ; To mitigate the impact of default risk, lenders often charge rates of return that correspond the debtor's level of default risk. The higher the risk , the higher the - required retwen and vice versa. sna TO m D୧OT 3. What's TRUE regarding long-term and shoot-term bonds ( assume they have the same pave value and coupon rate) ? · Long-terem bonde have higher geinvestment - risk is True. Explanation: heinvestment risk refers to the risk that the rate at which coupon and principal cash flows from a bond are reinvested will be lower than the expected rate in effect when the bond was purchased. Reinvestment risk increases - for bonds with longer maturities and - higher coupon payments, and decreases rinu einve 14 OX

bonds with shortex mafwrities and lower coupon rates: Also, Interest rate risk is the risk in terms of variability in the price of a bond borne by an interest - bearing asset due to variability of interest rates. As maturity of the fixed instrument increases, the interest rate increases - but at a decreasing rate . risk PLC