Which bond is likely to be the most volatile if they all mature in ten years?

Which bond is likely to be the most volatile if they all mature in ten years?

• A. Zero-coupon bond with 6% yield
• B. Corporate bond priced at par with 6% yield
• C. Corporate bond priced at par with 8% yield
• D. Zero-coupon bond with 8% yield

Answer: (A)

The most volatile bond among the choices provided is the zero-coupon bond with a 6% yield. The reason for this volatility is largely attributable to the structure of zero-coupon bonds. Unlike coupon-bearing bonds, which pay periodic interest throughout their life, zero-coupon bonds do not provide any cash flow until maturity. This means that their entire return is realized at the end of the investment period, causing their price to fluctuate significantly in response to changes in interest rates. As zero-coupon bonds are sold at a discount to their face value, the impact of interest rate changes is magnified. A small change in interest rates can lead to a large change in the price of a zero-coupon bond. Furthermore, since this particular zero-coupon bond has a yield of 6%, its relatively lower yield compared to the zero-coupon bond with 8% also influences its price sensitivity; as interest rates fluctuate, the fixed yield becomes more significant at a lower rate compared to higher yields, thus impacting the bond's price more drastically. In addition, corporate bonds—while also impacted by interest rates—tend to have lower volatility than zero-coupon bonds because they offer periodic interest payments, which provide some cash flow to the investor. This cash flow

The most volatile bond among the choices provided is the zero-coupon bond with a 6% yield. The reason for this volatility is largely attributable to the structure of zero-coupon bonds. Unlike coupon-bearing bonds, which pay periodic interest throughout their life, zero-coupon bonds do not provide any cash flow until maturity. This means that their entire return is realized at the end of the investment period, causing their price to fluctuate significantly in response to changes in interest rates.

As zero-coupon bonds are sold at a discount to their face value, the impact of interest rate changes is magnified. A small change in interest rates can lead to a large change in the price of a zero-coupon bond. Furthermore, since this particular zero-coupon bond has a yield of 6%, its relatively lower yield compared to the zero-coupon bond with 8% also influences its price sensitivity; as interest rates fluctuate, the fixed yield becomes more significant at a lower rate compared to higher yields, thus impacting the bond's price more drastically.

In addition, corporate bonds—while also impacted by interest rates—tend to have lower volatility than zero-coupon bonds because they offer periodic interest payments, which provide some cash flow to the investor. This cash flow