Question

Which of the following statements is CORRECT?

a. A 10-year coupon bond would have more price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of price risk.
b. A zero coupon bond of any maturity will have more price risk than any coupon bond, even a perpetuity.
c. If their maturities and other characteristics were the same, a 5% coupon bond would have more price risk than a 10% coupon bond.
d. A 10-year coupon bond would have more reinvestment risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment risk.
e. If their maturities and other characteristics were the same, a 5% coupon bond would have less price risk than a 10% coupon bond.

Answer 1

Answer: c. If their maturities and other characteristics were the same, a 5% coupon bond would have more price risk than a 10% coupon bond.

Explanation: Price risk in bonds is primarily associated with interest rate movements. When interest rates rise, bond prices tend to fall, and when interest rates decline, bond prices tend to rise. The relationship between coupon rates and price risk can be explained as follows:

A bond with a lower coupon rate (e.g., 5%) will have more price risk than a bond with a higher coupon rate (e.g., 10%) when their maturities and other characteristics are the same. This is because the lower coupon bond's cash flows are more reliant on the face value repayment at maturity, and its price is more sensitive to changes in interest rates.

Answer 2

Answer: c. If their maturities and other characteristics were the same, a 5% coupon bond would have more price risk than a 10% coupon bond.

Step-by-step explanation:

Price risk of a bond is the risk that the bond changes price or rather the degree of price volatility. Bond prices change in reaction to market interest rates with higher rates meaning lower prices and lower rates meaning higher prices.

When the market interest rates rise above the Coupon on a bond, the bond price will fall below par and when the interest rates are below the coupon, the bond will be above par.

A 5% coupon bond will be more prone to changes in prices because market interest rates are generally low and fluctuate below 10% which means that they will affect the 5% bond more than the 10% because there are better chances of rates rising above or falling below 5% than there are of 10%.