Fixed Income

CFA Level I
#1

Holding other factors constant, the interest rate risk of a coupon bond is higher when the bond’s: A) term to maturity is lower. B) coupon rate is higher. C) yield to maturity is lower. D) current yield is higher

#2

B) higter coupons?? - Dinesh S

#3

Thanks Dinesh for replying. I thought B was the answer too but According to Schweser the answer and explaination is: The correct answer was C) yield to maturity is lower. There are three features that determine the magnitude of the bond price volatility: The lower the coupon, the greater the bond price volatility. The longer the term to maturity, the greater the price volatility. The lower the initial yield, the greater the price volatility. In this case the only determinant that will cause a higher interest rate risk is having a low yield to maturity (initial yield). A higher coupon yield, a higher current yield, and a lower term to maturity will cause for lower interest rate risk.

#4

Please look at it and let me know what do you think…

#5

I picked C because a low yield means more sensitivity to changes in interest rates. a change in interest rates would create a higher % change in yields

#6

sorry Vishal, I think the correct answer is indeed C There’s some rule associated to it [Long Maturity OR Low Coupon OR Low YTM = HIGH RISK] … But, I am completely out of touch with Book-5, so can’t remember it exaclty… - Dinesh S

#7

Agree the answer should be C. Think of the price-yield curve. The slope is higher for lower yield and lower for higher yield. This simply means the price change to yield change is higher for lower yields. Also higher coupon means higher reinvestment risk not higher interest rate risk.

#8

Thanks Guys. got it.

#9

another way to look at this: Coupon Rate is Higher Current Yield is Higher are both saying the same thing. So these have to be eliminated. Viva, Multiple choice. So choice came down to Maturity is lower or YTM is lower If maturity is lower - you need to reinvest coupons for a shorter time. which might not be so bad. So Lower YTM is the answer by elimination.

#10

vishalarora Wrote: ------------------------------------------------------- > Thanks Dinesh for replying. > I thought B was the answer too but According to > Schweser the answer and explaination is: > > The correct answer was C) yield to maturity is > lower. > > There are three features that determine the > magnitude of the bond price volatility: > > The lower the coupon, the greater the bond price > volatility. > The longer the term to maturity, the greater the > price volatility. > The lower the initial yield, the greater the price > volatility. > In this case the only determinant that will cause > a higher interest rate risk is having a low yield > to maturity (initial yield). A higher coupon > yield, a higher current yield, and a lower term to > maturity will cause for lower interest rate risk. I like their solution but I don’t know that their solution leads to the answer. So if I buy a 6% T-bond at par and then America goes into a deep recession and the ytm drops to 0.01%, I now have more interest rate risk than I did previously? Hmm… I think “ytm of a bond” is just “price of bond”.