"Fixed Income": Interest rate risk of non-option bonds
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Questions 1:
An investor purchases an option-free bond paying an annual coupon rate of 10% and maturing in 10 years at its par value of $100. The investor sells the bond after seven years, receiving a total of seven coupons over this period. Assume that the coupons are reinvested at an annual interest rate of 8% over the investor’s holding period. The future value of the reinvested coupon payments at the end of the investor’s holding period is closest to:
A、 70.00.
B 、75.90.
C 、89.23.
Questions 2:
Which of the following statements is least accurate regarding the factors that affect the interest rate risk characteristics of an option-free bond?
A、 The lower the coupon rate, the greater the bond’s price sensitivity to changes in interest rates.
B、 The higher the yield, the greater the bond’s price sensitivity to changes in interest rates.
C、 The longer the bond’s maturity, the greater the bond’s price sensitivity to changes in interest rates.
C is correct. The future value of the reinvested coupon payments is computed as follows: 10(1.08)6 + 10(1.08)5 + 10(1.08)4 + 10(1.08)3 + 10(1.08)2 + 10(1.08)1 + 10 = 89.23 A is incorrect because it computes the future value of the coupon payment by just adding them up. 58 2019 Level I Mock Exam AM B is incorrect because it uses a reinvestment rate of 10% and a coupon payment of 8.00, as follows: 8(1.10)6 + 8(1.10)5 + 8(1.10)4 + 8(1.10)3 + 8(1.10)2 + 8(1.10)1 + 8 = 75.90
B is correct. Option-free bonds have positive convexity. The higher the yield to maturity, the lower the duration (and thus the lower the interest rate risk). A is incorrect because bonds with longer maturities have higher interest rate risks. C is incorrect because bonds with lower coupon rates have higher interest rate risks.
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