Question

If a bond's volatility is 5% and the interest rate changes by 0.5% (points), then the price of the bond:

a. Decreases by 0.5%
b. Decreases by 5%
c. Increases by 0.5%
d. Increases by 5%

Answer 1

The price of a bond is inversely related to changes in interest rates. When interest rates increase, the price of a bond decreases, and when interest rates decrease, the price of a bond increases. In this case, when the interest rate changes by 0.5%, the price of the bond increases by 2.5%.

Step-by-step explanation:

The price of a bond is inversely related to changes in interest rates. When interest rates increase, the price of a bond decreases, and when interest rates decrease, the price of a bond increases. The extent of the price change is influenced by the bond's volatility.

In this case, the bond's volatility is given as 5%. When the interest rate changes by 0.5% (points), the price of the bond will change by 5% multiplied by the 0.5% change in interest rate, which is 2.5%.

Therefore, the correct answer is d. Increases by 2.5%.