Which of the following statements is CORRECT?
A) 10-year, zero coupon bonds have more reinvestment rate risk than 10-year, 10% coupon bonds.
B) A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all else equal).
C) The total (rate of) return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year, divided by the bond's price at the beginning of the year.
D) The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond.
E) A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.

Question

Quizplus · Accepted Answer

The total return on a bond during a given year is calculated by adding the coupon interest payments received during the year to the change in the value of the bond from the beginning to the end of the year, divided by the bond's price at the beginning of the year. This is known as the holding period return. The reinvestment rate risk is higher for zero coupon bonds because they do not pay any interest until maturity, so the investor has to reinvest the proceeds at the prevailing interest rate at that time. The sensitivity of bond prices to changes in interest rates, or interest rate risk, is higher for longer-term bonds, so a 20-year, 10% bond would be more sensitive to interest rate changes than a 5-year, 10% bond. The statement about the discount or premium at different interest rates is also correct, as the bond's yield would need to be adjusted to match the prevailing interest rates in the market.

Which of the Following Statements Is CORRECT