FINRA Series 7Investment Information and Suitable RecommendationsMedium
An investor is comparing two bonds of the same issuer and credit quality: Bond A has a 10-year maturity and a 6% coupon; Bond B has a 20-year maturity and a 3% coupon. If interest rates rise sharply, which bond will experience the greatest decline in price?
- ABond A, because it has the higher coupon rate
- BNeither bond will be significantly affected since both are same issuer
- CBond B, because it has a longer maturity and lower coupon rate
- DBoth bonds will decline by an equal percentage
Show answer & explanationAnswer & explanation
Correct answer: C. Bond B, because it has a longer maturity and lower coupon rate
Bond price volatility (duration) increases with longer maturity and lower coupon rate. Bond B, with a longer maturity and lower coupon, has higher duration and will therefore experience a greater price decline when interest rates rise.
Why the other options are wrong
- A. Incorrect — the higher coupon and shorter maturity make Bond A less volatile, not more.
- B. Incorrect — issuer being the same does not offset the duration difference.
- D. Incorrect — duration differs significantly between the two bonds.
Interest Rate Risk / Duration
The sensitivity of a bond's price to changes in interest rates; longer maturities and lower coupon rates increase price volatility (duration).
- Longer maturity = greater interest rate risk
- Lower coupon rate = greater interest rate risk
- Zero-coupon bonds have the highest duration for a given maturity
Memory trick: Long and low (maturity long, coupon low) means price falls the fastest.