6. Price risk and reinvestment rate risk Which of the following statements are t

Question

6. Price risk and reinvestment rate risk Which of the following statements are true? Check all that apply. ? If interest rates increase, the coupon rate on newly issued bonds will decrease. ? Rising interest rates result in a capital gain for bondholders. An increase in interest rates will lead to a decrease in the price of an outstanding bond Purchasing long-term bonds reduces an investor's interest rate risk. Which of the following bonds has the highest reinvestment rate risk? 5% municipal bond, callable after 3 years 5% corporate bond, callable after 7 years 5% corporate bond, 10-year maturity, noncallable O Zero-coupon bond

Explanation / Answer

Statement 3 and 4 are correct

With an increase in interest rates, outstanding bonds become less desirable and hence leads to a fall in their prices

Purchasing long term bonds, investor secures a fixed interest payment and hence reduces investor's interest rate risk

Statement 1- Coupon Rate never changes

Statement2- Rise in interest rates do not lead to a capital gain but loss since the prices of outstanding bonds fall

Callable bonds carry high reinvestment rate risk since companies call their bonds when interest rates are low

Hence, 5% municipal bond, callable after 3 years has the highest reinvestment rate risk

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