Which of the following statements is true? Explain why. 1. Ignoring interest acc

Question

Which of the following statements is true? Explain why.

1. Ignoring interest accrued between payment dates, if the required rate of return on a bond is less than its coupon interest rate, and the cost of debt remains below the coupon rate until maturity, then the market value of that bond will be below its par value until the bond matures, at which time its market value will equal its par value.

2. Assuming equal coupon rates, a 20 year original maturity bond with one year left to maturity has more interest rate risk than a 10 year original maturity bond with one year left to maturity.

3. Regardless of the size of the coupon payment, the price of a bond moves in the same direction as interest rates; bond prices also rise.

4. For bonds, price sensitivity to a given change in interest rates generally increases as years remaining to maturity increases.

Explanation / Answer

The last statement is correct.

Price sensitivity of bond is higher for higher maturity bonds than lower maturity bonds as the change in interest rates would impact future cash flows from the bond, which would be higher for bonds with higher maturity.

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