Question

Of these choices, a risk-adverse investor who prefers to minimize interest rate risk is most apt to invest in which of the following?

1) 5-year, 7 percent coupon bonds.
2) 20-year, 6 percent coupon bonds.
3) 20-year, zero coupon bonds.
4) 2-year, 7 percent coupon bonds.
5) 3-year, zero coupon bonds.

Answer 1

A risk-averse investor aiming to minimize interest rate risk would likely choose 2-year, 7 percent coupon bonds because shorter maturity reduces interest rate sensitivity and periodic interest payments are advantageous.

Step-by-step explanation:

A risk-averse investor, who prefers to minimize interest rate risk, would most likely invest in 2-year, 7 percent coupon bonds. The reason is that shorter-term bonds are less sensitive to changes in interest rates compared to longer-term bonds. When interest rates rise, the price of existing bonds falls to compensate for the higher yields available on new bonds. As a result, investors holding long-term bonds experience more significant price fluctuations compared to those holding short-term bonds. Additionally, a 7 percent coupon bond provides periodic interest payments, which can be preferable over zero-coupon bonds that don't make any payments until maturity.