Question

Xerox just issued two bonds. The 1st Bond is a zero coupon bond with 30 year to maturity. The 2nd Bond is a 10% coupon bond with 10 year to maturity. Assume that other characteristics of these two bonds are the same (e.g., the same YTM). You expect that the Fed will announce a decrease of benchmark interest rate. Which bond do you want to purchase in order to earn higher return around the incoming interest rate change?A) The 1st bond issued by Xerox.B) The 2nd bond issued by Xerox.

Answer 1

Answer:

Purchase 1st bond

Explanation:

Given data:

1st bond : zero coupon , 30 years to maturity,

2nd bond : 10% coupon bond , 10 year to maturity

Assuming other characteristics are the same.  

when the interest rate change the Bond that is mostly likely to earn a higher return is the 1st bond, because the duration of the bond is higher than the duration of the 2nd bond, Also the Duration to maturity of bonds decreases with increase in coupon.