Study Question of the Week: January 3, 2013 Edition

This week’s study question from the Solomon Online Exam Simulator question database is now available. Relevant to the Series 7, Series 62, Series 65, Series 66, Series 79, and Series 82. –ANSWER POSTED– Continue reading

This week’s study question from the Solomon Online Exam Simulator question database is now available.

Question (Relevant to the Series 7Series 62Series 65, Series 66, Series 79, and Series 82):
Two corporate bonds have different durations, but are equivalent in other ways. Bond A has a duration of 6. Bond B has a duration of 4. Interest rates go down by 50 basis points. Which of the following is true?

Answers:

A: The price of Bond A will increase more than the price of Bond B

B: The price of Bond A will decrease more than the price of Bond B

C: The price of both bonds will increase by a similar amount

D: The price of both bonds will decrease by a similar amount

Correct Answer: A

Rationale: Duration is a measure of the sensitivity of a bond’s price to changes in interest rates. A price of a bond with a higher duration will be influenced more by a change in interest rates than a bond with a lower duration. Bond A has a higher duration so it will be influenced by a change in interest rates more than Bond B. When interest rates go down, the prices of existing bonds go up. Thus, a decline in interest rates will cause the price of both bonds to increase, but because Bond A has a higher duration than Bond B, its price will go up more than Bond B.

Weekly study questions are from Solomon’s industry-leading Online Exam Simulator.

Leave a Reply

Your email address will not be published.