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Treasury Bonds and Interest Rate Risk

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Which of the following Treasury bonds will have the largest amount of interest rate risk (price risk) and why?

A. A 7% coupon bond which matures in 12 years.

B. A 9% coupon bond whic matures in 10 years.

C. A 12% coupon bond which matures in 7 years.

D. A 7% coupon bond which matures in 9 years.

E. A 10% coupon bond which matures in 10 years
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Solution Summary

Interest rate risk is inversely proportional to the current yield to maturity of a bond-the higher the yield to maturity, the less the price will change for a given change in interest rates. This makes sense because any change in interest rates will be a smaller percentage of a high YTM than for a smaller YTM.

Interest rate risk is also inversely proportional to the coupon rate of the bond. The higher the coupon rate, the less the bond price changes for a given change in interest rates. Since the coupon payments are larger, the bondholder receives more money earlier, which increases the present value of the bond's future cash flow.

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The response is e. A 10% coupon bond which matures in 10 years. You would make the most money with this if the interest rates stayed the same and you planned on keeping it to maturity, however, this one also carries the more risk because of it's length in time until ...

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