Bond Duration

Question 1

What happens if interest rates in the economy go up or down after you buy a bond?

Answer 1

The value of the bond changes

Question 2

What happens to bonds if rates go up? Is this good or bad for the holder of the bond? And why?

Answer 2

New bonds pay more interest than mine.

Therefore, my bond looks less attractive and its price drops.

Question 3

What happens to the value of the bond if rates go down? Is this good or bad for the holder of the bond and why?

Answer 3

If rates go down, my bond pays more than new ones.

Therefore, my bond becomes more valuable in its price rises.

Question 4

What is it called when the risk that a bonds price will move because of change changes in interest rate rates called

Answer 4

Interest rate risk

Question 5

Which term bonds are more sensitive to interest rate changes and why?

Answer 5

Long-term bonds

Because the owner of the bond is locked into a fixed rate for a longer period of time.

Question 6

If an investor holds a long-term bond, an interest rates rise why is this bad for the investor?

Answer 6

Because they have a low paying bond when coupon rates are much higher.

Question 7

What are the two key factors that determine how much a bonds price will move?

Answer 7

Maturity

Coupon (how much the bond pays)

Question 8

What type of coupon would be more sensitive to interest rate movement? Why?

Answer 8

Low coupon bonds are more sensitive than high coupon ones.

Because most of your return comes far in the future (final repayment) which is affected by interest rate changes.

Question 9

What should investor do if interest rates are expected to rise?

Answer 9

Buy bonds with short maturities, even though they will have low coupons.

UPS - interest rates UP, Shorten

Question 10

If interest rates are expected to fall, what should an investor do?

Answer 10

Buy bonds with long maturities, to lock in the high coupon for as long as possible.

FALLEN - FAL for fall and LEN for lengthen

Question 11

What is the correlation between interest rates and duration?

Answer 11

Inverse relationship

Question 12

If interest rates rise in the duration falls, why is this important?

Answer 12

The weighted timing of the bond payments shifts earlier.

Meaning the present value of future payments drops or discounted more heavily.

Question 13

What happens to duration if interest rates fall?

Answer 13

The duration gets longer.

Meaning the present value of future payments increase but short term present value payments decrease