A security with higher risk will have a higher expected return. A bond\'s risk l

Question

A security with higher risk will have a higher expected return. A bond's risk level is reflected in its yield, but understanding the different risks involved when investing in bonds is important. The curves on the following graph show the prices of two 10% annual coupon bonds at various interest rates. BOND VALUE IS 1750 1500 1250 1000 750 1-Year Bond 500 10-Year Bond 250 12 20 INTEREST RATE [96] Based on the graph, which of the following statements is true? Both bonds have equal interest rate risk. O The 1-year bond has more interest rate risk O The 10-year bond has more interest rate risk. O Neither bond has any interest rate risk. Frank Barlowe is retiring soon, so he is concerned about his investments providing him with a steady income every year. He is aware that if interest rates investments will increase. In particular, he is concerned that a decline in interest rates might lead to annual income from his investments. What kind of risk is Frank most concerned about protecting against? , the potential earnings power of the cash flow from his O Reinvestment rate risk O Interest rate risk Answer the following question based on your understanding of interest rate risk and reinvestment rate risk. True or False: Assuming all else is equal, long-term securities are exposed to higher interest rate risk than short-term securities True O False

Explanation / Answer

1.

Correct option is > The 10-Year bond has more interest rate risk

The graph depicts that as interest rate is increasing the value or price of the bond is falling and for a longer-term bond there is more discounting period hence prices are influenced by interest rates.

2.

Correct option is > Reinvestment rate risk

Dash should be filled with ----- Increase, less

The reinvestment rate risk is associated when there is fall in present interest rate. The opportunity for generating higher income through interest shrinks.

3.

True

Long term securities are exposed to higher interest rate risk. The interest rates are discounting factors hence it affects the present values.

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