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Chapter 4: Q.11 (page 134)

If interest rates decline, which would you rather be holding, long-term bonds or short-term bonds? Why? Which type of bond has the greater interest-rate risk?

Short Answer

Expert verified

In such a situation, long term investment will be a better option.

Step by step solution

01

Step 1. Introduction

An interest rate indicates how much it costs to borrow money or how much it pays to save money. So, if you're a borrower, the interest rate is the cost of borrowing money expressed as a percentage of the entire loan amount.

02

Step 2. Explanation

Long-term bonds would be a better investment since their price would rise faster than short-term bonds, offering you a bigger return. Longer-term bonds are more vulnerable to price swings than shorter-term bonds, posing a higher risk of interest rate fluctuations.

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Most popular questions from this chapter

Interest rates were lower in the mid-1980s than in the late 1970s, yet many economists have commented that real interest rates were actually much higher in the mid1980s than in the late 1970s. Does this make sense? Do you think that these economists are right?

To help pay for college, you have just taken out a \(1,000 government loan that makes you pay \)126 per year for 25 years. However, you don鈥檛 have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12%? (This is the yield to maturity on a normal \(1,000 fixed-payment loan on which you pay \)126 per year for 25 years.)

Property taxes in a particular district are 2% of the purchase price of a home every year. If you just purchased a \(150,000 home, what is the present value of all the future property tax payments? Assume that the house remains worth \)150,000 forever, property tax rates never change, and a 4% interest rate is used for discounting.

Would $200, which is to be received in exactly one year, be worth more to you today when the interest rate is 12% or when it is 17%?

In this chapter, we discussed long-term bonds as if there were only one type, coupon bonds. In fact, investors can also purchase long-term discount bonds. A discount bond is sold at a low price, and the whole return comes in the form of a price appreciation. You can easily compute the current price of a discount bond by using the financial calculator at http://www .treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm.

To compute the values for savings bonds, read the instructions on the page and click on Get Started. Fill in the information (you do not need to fill in the Bond Serial Number field) and click on Calculate.
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