CFA Practice Question

There are 266 practice questions for this study session.

CFA Practice Question

Which of the following statements is false with respect to the price volatility of a bond arising out of changes in the yield curve?
A. Government bonds will always be less volatile than corporate bonds.
B. Higher coupon paying bonds will always be less volatile than low coupon paying bonds, holding everything else constant.
C. For a one basis point change in yield, a bond will be less volatile at higher levels of yield than it would be at lower levels of yield.
Explanation: When it comes to interest rate risk, not even government bonds are immune. In fact, a long-term government bond's price will be a lot more volatile than a short-term corporate bond's price. This is true despite the fact that corporate bonds have a credit risk.

User Contributed Comments 3

User Comment
steved333 Which one is FALSE!!! (No wonder this was such a hard one since all but one seemed true...)
drewnelson C is false. The duration of a bond at higher levels of yield (discount) is larger than the bond would be at lower levels of yield (premium) holding everything constant. Higher duration - higher sensitivity to changes in interest rates. The bond would be MORE volatile at higher levels of yield.
myron @drewnelson: your comment is completely wrong. C is true by common sense. For a one basis point change in yield (ABSOLUTE VALUE), the proportional yield change is larger at lower levels of yield than at higher levels. For example, compare a 100 basis point change when a bond is yielding at 2% and at 20%: for the 2% yield it would be a 50% relative yield change while for the 20% yield level it would be a 5% relative yield change.

And more importantly, yield-to-maturity is inversely related to Macaulay duration and modified duration. This means the duration will be smaller if yield goes up (contrary to what you state). The higher duration at lower yield level will make a bond more volatile.
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