Impact of Interest Rate Volatility on Bond Pricing

Medium Term Structure Dynamics Interest Rate Volatility

Consider a fixed income investment environment characterized by fluctuating interest rates. Interest rate volatility is a crucial factor that affects the pricing and performance of fixed income securities. A recent study indicates that the term structure of interest rates tends to steepen in environments of high volatility. The yield curve shifts due to changes in the market's expectations of future interest rates.

Given this context, which of the following statements accurately describes the impact of interest rate volatility on a bond's pricing and yield?

Higher interest rate volatility typically leads to lower bond prices and higher yields, as investors demand greater compensation for risk.

Interest rate volatility has no significant effect on long-term bonds, since their cash flows are predictable regardless of market fluctuations.

Lower interest rate volatility helps in stabilizing bond prices, therefore reducing yield spreads between government and corporate bonds.

Hint

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