Which of the following statements is CORRECT?
A)If interest rates increase, a 10-year zero coupon bond's price will drop by a greater percentage than will a 10-year, 8% coupon bond.
B)One nice thing about zero coupon bonds is that individual investors do not have to pay any taxes on a zero coupon bond until it matures, even if they are not holding the bonds as part of a tax-deferred account.
C)If a bond with a sinking fund provision has a yield to maturity greater than its coupon rate, the issuing company would prefer to comply with the sinking fund by calling the bonds in at par rather than buying the bonds back in the open market.
D)Because of the IRS's tax treatment of zero coupon bonds, pension funds and other tax-exempt entities rarely, if ever, invest in zero coupon bonds.
E)Interest must be paid on a zero coupon bond's accrued value, but while the first year's interest is taxable at the ordinary income tax rate, subsequent years are taxed at the long-term capital gains rate (since they are received after more than a year).

Question

Quizplus · Accepted Answer

A 10-year zero coupon bond has no coupon payments, so it is entirely exposed to interest rate risk. Therefore, an increase in interest rates would have a greater impact on its price than on a 10-year, 8% coupon bond, which would still provide a regular income stream even if interest rates rise.

Which of the Following Statements Is CORRECT