To determine: Reconciliation of the two empirical observations that the price and yields to maturity of long term bonds are more volatile than short term bonds.
Introduction: In long term bonds, the issuer pay higher interest rates for exchange of more security. The short term bonds have minimum period for maturity,but they provide a higher liquidity.
Answer to Problem 1PS
Short term bonds are more volatile in terms of yields to maturity and long term bonds are more volatile in terms of price.
Explanation of Solution
Given Information:
Prices and yields to maturity for both long and short terms of bond are given.
As in Short term bonds, the yielding amount is low the risk factor involved is minimum. On the other hand the long term bonds pose agreater risk, because the investor’s money is locked up for longer period. There would be chances of price fluctuations.
In long term bond, the maturity period is higher in comparison to the short term bonds. So, the price in long term is more sensitive than that of the short term bonds.
The rate of charged interests may be fluctuating with higher duration than the near future. So, yields to maturity in short term bonds are more volatile.
Hence, the long duration of maturity period makes the long term bonds more volatile in price but less volatile in terms of interest.
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Chapter 16 Solutions
INVESTMENTS-LOOSELEAF
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