MediumHard A shortte bond has reinvestment risk than a short

(Medium/Hard) A short-te bond has_ reinvestment risk than a short-term bond. A discount bond\'s price tends to be _ price risk than a long-term bond. A long-term next year. A) Higher, higher, higher B) Lower, higher, higher c) Higher, lower, lower D) None of the above is correct. E) Lower, lower, lower

Solution

Answer is B. Lower, Higher and Higher

A short term bond has lower price risk, which means its price will be less sensitive to interest rates. Duration or interest rate sensitivity of a bond is higher for bond with longer term (keeping other things constant). So longer term bond will have higher duration and hence higher price risk or change in price due to change in interest rates.

A long term bond has a higher reinvestment risk. Reinvestment risk is the risk of reinvesting the coupons earned at a rate lower than that of the YTM. Since, during longer maturity, there is a higher probability of change (od rather decline) in interest rates which may lead to lower than expected rate of return earned.

A discount bond \'s price thends to be higher next year. During the course of bond\'s life, the price of bond will move towards its face value or maturity value. For a discount bond, this implies price will increase year over year to move to maturity value by its expiration. For a premium bond, this implies price will decrease year over year to move to maturity value by its expiration.