CFA Practice Question

CFA Practice Question

If a bond investor believes that interest rates will experience a large increase, he should hold a portfolio of ______.
A. long-term bonds with high coupons
B. intermediate-term bonds with low coupons
C. short-term bonds with high coupons
Explanation: Studies have found that bond price volatility is directly related with term to maturity and inversely related to coupon size. All bonds should experience price declines because of a major increase in interest rates, but short-term, high-coupon bonds will experience the smallest decline because their characteristics decrease their price volatility, making them less sensitive to adverse changes in interest rates. First, the financial commitment is short-term, so at the end of the period investors can parlay the money into the market, and second, in the interim, higher coupon payments will allow them to invest a higher payment at current increasing market rates.

User Contributed Comments 4

User Comment
dimanyc good explanation!
meiko yeah! yield curve baby!
alexchav Duh, I had an incredibly complex explanation. It was so simple.
epfrndz Short term bonds also have lower durations, which indicates lower price sensitivity to changes in interest rates.
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