Impact of Interest Rate Volatility on Different Bond Types

Hard Term Structure Dynamics Interest Rate Volatility

In the context of fixed income securities, interest rate volatility is a critical factor influencing the pricing of bonds and other debt instruments. It is commonly accepted that different types of bonds react differently to changes in interest rates. Consider the following three types of bonds:

1. Long-term zero-coupon bonds

2. Short-term coupon bonds

3. Perpetual bonds

Each bond type has distinct characteristics that will respond to fluctuations in interest rates. Understanding how interest rate volatility affects these different bonds can help investors manage risk and optimize their investment strategies.

Which of the following statements accurately describes the impact of interest rate volatility on bond prices?

Long-term zero-coupon bonds are generally more sensitive to interest rate volatility than short-term coupon bonds due to their longer duration.

Perpetual bonds have lower price sensitivity to interest rate changes compared to long-term zero-coupon bonds because they pay coupons indefinitely.

Short-term coupon bonds exhibit greater changes in price as interest rates fluctuate compared to long-term zero-coupon bonds.

Hint

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