Final answer:
Long-term bonds experience greater price variability compared to short-term bonds when interest rates change. Bond prices will be above face value if market rates fall and below face value if market rates rise, reflecting the present value of future payments.
Step-by-step explanation:
Regarding the question of whether short-term (ST) or long-term (LT) bonds experience more price variability as interest rates change, it is important to understand that long-term bonds generally exhibit greater price volatility.
This is because they have a longer time horizon for potential interest rate changes to affect the present value of their future coupon payments and principal repayment.
When it comes to the impact of changing interest rates on bond prices, if interest rates fall, the price of a previously issued bond with a higher coupon rate becomes more attractive and thus the bond will sell for more than its face value.
Conversely, if interest rates rise, the bond will sell for less than its face value, as it is offering a lower rate compared to new bonds in the market. Real-world calculations can be more complex due to other factors such as credit risk, but the fundamental concept remains that bond prices and interest rates are inversely related, and the price is the present value of a stream of future expected payments.