Final answer:
Bond D, with a 20-year maturity, will be most affected by an increase in yields by 20 basis points due to its longer duration, which makes it more sensitive to changes in interest rates.
Step-by-step explanation:
When considering Four bonds of similar quality each with the same coupon rate, but with varying maturity dates, the bond's sensitivity to interest rate changes, known as duration, plays a significant role. The bond that matures in 20 years, Bond D, would be the most affected by an increase in yields by 20 basis points. This is because longer-term bonds have greater duration, meaning they are more sensitive to changes in interest rates. When yields increase, bond prices fall, and the impact of a change in yield is more pronounced for bonds with a longer time until maturity.
Bonds are debt securities that companies and governments issue to raise capital. Investors receive periodic coupon payments and the repayment of the principal amount at maturity. However, if market interest rates rise, as in this scenario, newly issued bonds would offer a higher yield, making existing bonds with lower rates less attractive, thus decreasing their market price.
When interest rates increase, the price of existing bonds typically decreases. This is because new bonds are issued with higher coupon rates, making existing bonds less attractive to investors. The effect of the interest rate increase on bond prices is inversely related to their maturity. The longer the maturity, the greater the impact on the bond price.
In this case, Bond D has the longest maturity of 20 years and therefore would be most affected by the 20 basis point increase in yields. Bond prices are more sensitive to changes in interest rates the further they are from maturity.