Final answer:
Bonds with longer maturities and lower coupon rates are more sensitive to interest rate drops, and their value increases when market rates fall. In contrast, bonds with shorter maturities and higher coupons are less sensitive. The value of a bond will decrease if the market interest rate rises above its coupon rate.
Step-by-step explanation:
When considering the sensitivity of bonds to changes in interest rates, bonds with longer maturities and lower coupon rates tend to be more sensitive. When interest rates drop, existing bonds with higher coupon rates become more valuable because they offer returns higher than the new bonds issued at the current lower rates. Conversely, bonds with shorter maturities and higher coupon rates are less sensitive to changes in interest rates.
Should the market interest rates fall, for a $10,000 bond with an interest rate initially higher than the new market rate, you would expect to pay more than $10,000 for the bond. If the interest rates rise, such as from 3% to 4%, the value of the bond will decrease. This is because new bonds issued will offer a higher return, making the lower-interest bonds less attractive.
Additionally, when the market interest rate rises from 6% to 9%, you would expect to pay less than $10,000 for the bond. It's because the fixed return from the bond is now less than what could be earned elsewhere in the market at the new higher rate.