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Question 12 (0.5 points) A bonds sensitivity to changes in market interest rates decreases when the: I. time to maturity inc
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A bond's sensitivity to changes in market interest rates decreases as time to maturity decreases (option II) and coupon rate increases (option III). Suppose interest rates increase then for a bond with 2 year maturity, one would be earning lower returns for 2 years compared to a bond with say, 10 year maturity which would earn lower returns for 10 years vis-a-vis the higher market interest rates. So, bonds with longer maturity are more affected by changes in interest rates than bonds with lower maturity.

Similarly, when coupon rates are higher then more cash flows are available to the investor before maturity so when interest rates rise then lower coupon bonds have more comparatively more cash flow in the far off future so the major part of the total cash flow will be closer to maturity of the bond than before. As a result, the bond price today will fall more compared to a higher coupon bond.

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