Impact of Interest Rate Volatility on Long-Term Bond Pricing

Hard Term Structure Dynamics Interest Rate Volatility

A fixed income analyst has been studying the impact of interest rate volatility on the pricing of long-term bonds. She knows that changes in interest rate volatility can have a profound effect on the term structure of interest rates, which in turn influences bond prices.

Specifically, she is analyzing a hypothetical bond that has similar characteristics to a 30-year Treasury bond. She observes that during periods of high interest rate volatility, the bond’s price is more sensitive to changes in yields compared to periods of low volatility. This leads her to consider how interest rate volatility affects yield curves and the valuation of fixed income securities.

Based on her analysis, she seeks to determine which of the following statements accurately describes the relationship between interest rate volatility and the pricing of long-term bonds.

Higher interest rate volatility leads to a steeper yield curve when the yield curve is upward sloping.

Increased interest rate volatility generally decreases the convexity of long-term bonds.

Higher interest rate volatility reduces the pricing sensitivity of long-term bonds to interest rate changes.

Hint

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