Question

Which of the following bond prices is most sensitive to changes in interest rates?

a) 5-year zero-coupon bond
b) 1 -year 5% coupon bond
c) 5-year 10% coupon bond
d) 30-year zero coupon bond
e) 30 -year 10% coupon bond

Answer 1

The 1-year 5% coupon bond is the most sensitive to changes in interest rates.

Step-by-step explanation:

The bond price that is most sensitive to changes in interest rates is the 1-year 5% coupon bond.

When interest rates rise, the value of existing bonds decreases because investors can now earn a higher return elsewhere. For bonds with longer maturities, such as the 5-year and 30-year bonds, there is a greater chance for interest rates to change over such a long period. However, the 1-year bond is more sensitive to interest rate changes because its shorter maturity means its cash flows are received sooner and can be reinvested at potentially higher rates.