Question

12. Price risk and reinvestment rate risk Aa Aa Which of the following statements are true? Check all that apply. Bonds with similar coupons will always have the same percentage price change, no matter the maturity. Rising interest rates cause the value of outstanding bonds to decrease A decline in interest rates will lead to a decline in the price of an outstanding bond To minimize interest rate risk, an investor should buy long-term bonds. Which of the following bonds has the highest reinvestment rate risk? 0 Callable 4% coupon bond O Zero-coupon bond 0 Callable 6% coupon bond O Noncallable 6% coupon bond

Answer 1

Bonds with similar coupons will always have the same percentage price change,no matter the maturity. False

Rising interest rates cause the value of outstanding bonds to decrease. (Price of bond and interest rate are inversely proportional) True

A decline in interest rate will lead to a decline in the price of outstanding bonds. False

To minimize interest rate risk, an investor should buy long term bonds. False (Increase of tenure of bond increases interest rate risk)

The bond which has highest reinvestment risk is Callable 6% coupon bond.

Explanation: Zero coupon bond does not have reinvestment risk as issuer will pay all interest and principal at maturity. A 6% callable bond has more interest rate risk than 4% callable bond as it has more room to come down. A 6% callable bond has more interest rate risk than a 6% non-callable bond because in case of interest rate risk decrease, the issuer will redeem the callable bond and reissue the bond at lower interest rate.So, investor has highest risk for callable 6% coupon bond.