Final answer:
Increases in interest rates cause bond prices to fall, with the percent price change for zero-coupon bonds being more substantial than for coupon-bearing bonds, because zero-coupon bonds' return is solely at maturity.
Step-by-step explanation:
Why does the percent change in a bond's price of a zero-coupon bond exceed the percent change in bond's price of a coupon-bearing bond? When it comes to bonds and interest rates, there is an inverse relationship between the two. Specifically, if interest rates increase, the price of a previously issued bond will likely decrease.
Zero-coupon bonds pay no regular interest; they are sold at a discount and the return is realized when the bond matures. Given these characteristics, zero-coupon bonds are more sensitive to interest rate changes because their value is solely based on the discounted present value of the maturity payment. The percent change in the price of a zero-coupon bond will be more substantial compared to coupon-bearing bonds, which pay interest periodically, thus lessening some of the impacts due to rate changes.
If the interest rate rises, the price of both types of bonds will decrease because new bonds will likely be issued at the higher rate, making the older, lower-yielding bonds less attractive. However, an existing zero-coupon bond must decrease more in price to become competitive with new bonds that have higher rates, hence the more significant percent change in price.