Question

Consider the following bonds:

                                               

Bond	Coupon Rate (annual payments)	Maturity (years)
A	0%	13
B	0%	8
C	4%	13
D	12%	8

a. What is the percentage change in the price of each bond if its yield to maturity falls from 7% to 6%?

b. Which of the bonds A−D is most sensitive to a 1% drop in interest rates from 7% to 6% and why? Which bond is least sensitive? Provide an intuitive explanation for your answer.

Note: Assume annual compounding.

Answer 1

Which of the bonds A through D  is most sensitive to a 1% drop in interest rates, from 7% to 6%, and why?

Answer: Bond A, because it has the lowest coupon and longest maturity.

Which of the bonds A through D is least sensitive to a 1% drop in interest rates, from 7% to 6%, and why?

answer: Bond D, because it has the highest coupon and shortest maturity