5. Interest rate and reinvestment rate risk Aa Aa The graph below describes the

Question

5. Interest rate and reinvestment rate risk Aa Aa The graph below describes the price of two 1 annual coupon bonds. The curves on the graph show the price of 0% each bond at various terest rates BOND VALUE 2000 1750 1500 1250 1-Year Bond 1000 500 0-Year Bond 250 20 NTEREST RATE According to the graph, which bond has more interest rate risk? O The 10-year bond O The 1-year bond O They have equal interest rate risk O Neither bond has any interest rate risk Frank Bernanke is retiring soon, so he is very concerned about his investments providing him steady income every year. In particular, he is concerned that a decline in interest rates might lead to less annual income from his investments. What kind of risk is Frank most concerned about protecting against? O Interest rate risk O Reinvestment rate risk Which of the following bonds poses the biggest risk to Frank's investment goals? O 30-year, 0% coupon bond O 20-year, 0% coupon bond O 20-year, 10% coupon bond that may be called in 10 years O 20-year, 10% coupon bond O 30-year, 10% coupon bond

Explanation / Answer

Solution-

10 Year Bond

(According to graph the intrest rate risk is more in 10-year bonds because the 10 years bond gives higher inerest with higher risk)

Solution-

Reinvestment Rate Risk

(Frank Bernanke required a stedy income from the investment for that he has to go with reinvestment rate risk.)

Solution-

30 year, 0% coupon bond

(30 year, 0% coupon bond because the duration of zero coupon bonds is the number of years to maturity itself so 30 year, 0% coupon bond is much risky.)

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