Which of the following statements about the relationship between interest rates and bond prices is true?Group of answer choicesThere is an inverse relationship between bond prices and interest rates, and the price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).There is a direct relationship between bond prices and interest rates, and the price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).There is an inverse relationship between bond prices and interest rates, and the price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).There is a direct relationship between bond prices and interest rates, and the price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).
Question
Which of the following statements about the relationship between interest rates and bond prices is true?Group of answer choicesThere is an inverse relationship between bond prices and interest rates, and the price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).There is a direct relationship between bond prices and interest rates, and the price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).There is an inverse relationship between bond prices and interest rates, and the price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).There is a direct relationship between bond prices and interest rates, and the price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).
Solution
The correct statement is: "There is an inverse relationship between bond prices and interest rates, and the price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both)."
Here's why:
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There is an inverse relationship between bond prices and interest rates. When interest rates rise, bond prices fall, and vice versa. This is because as interest rates increase, new bonds come to market paying higher interest rates than existing bonds, making those existing bonds less attractive and therefore, their prices drop.
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The price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates. This is due to a concept known as interest rate risk, which is the risk that changes in interest rates will negatively affect the value of a bond. Long-term bonds have a greater duration or sensitivity to changes in interest rates, so their prices will fluctuate more than short-term bonds for a given change in interest rates.
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