16- Bond B is a discount bond with face value of $100 and maturity of 2 years. S

Question

16-

Bond B is a discount bond with face value of $100 and maturity of 2 years.

Suppose the yield to maturity on both bonds is currently 4%.

Over the course of the year, prevailing yields are expected to change according to the table below:

Expected returns of bonds A and B are very close in value. Assuming the expected returns are the same, which bond would a risk averse investor prefer?

Bond B

A risk averse investor would not prefer A over B or vice versa.

Bond A

Bond A is a discount bond with face value of $100 and maturity of 10 years.

Bond B is a discount bond with face value of $100 and maturity of 2 years.

Suppose the yield to maturity on both bonds is currently 4%.

Over the course of the year, prevailing yields are expected to change according to the table below:

Next year's yield Probability 3% 0.33 4% 0.34 5% 0.33

Explanation / Answer

Correct Answer:

Bond B

Explanation:

There is a fluctuation in yield rate and risk averse investor would like to choose a bond that has shorter maturity period. The bond B offers relatively shorter maturity period, so it will be selected.

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