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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Investing in Fixed Income Securities

A 5-year bond with a face value of Rs 1,000 pays an annual coupon of 8% and is priced at Rs 1,000 today. An investor expects the market yield to fall to 7% immediately. Compared with a similar 5-year zero-coupon bond of the same yield, which statement is correct for the coupon bond's price change?

The coupon bond rises less than the zero-coupon bond. Coupons return cash earlier, so its duration is below five years, whereas the zero-coupon bond's duration equals its maturity. Lower duration means smaller price sensitivity to a fall in yields.

  1. AIt rises less than the zero-coupon bond because its duration is lowerCorrect
  2. BIt rises more than the zero-coupon bond because coupons raise duration
  3. CIt does not change because the coupon is fixed
  4. DIt falls because the coupon is above the new yield

Explanation

A coupon bond returns part of its value early, so its Macaulay duration is below its maturity of 5 years, while a zero-coupon bond has duration equal to maturity. Lower duration means lower price sensitivity, so the coupon bond gains less when yields fall. Coupons raising duration is the opposite of the truth.

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