Duration measures the sensitivity of a fixed-income security's price to changes in interest rates.
Which of the following best describes the relationship between a bond's duration and its interest rate risk?
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A) A bond with a longer duration has more interest rate risk. B) A bond with a shorter duration has less interest rate risk. C) A bond with a longer duration has less reinvestment risk. D) A bond with a shorter duration has less interest rate risk.
Which of the following is a strategy used to protect a bond portfolio from interest rate risk by matching the duration of assets and liabilities?
A) Immunization is a strategy to protect a bond portfolio from interest rate risk by matching the duration of assets and liabilities. B) Diversification is a strategy to reduce risk by investing in various assets. C) Hedging is a strategy used to offset the risk of one investment by making another investment with a negative correlation. D) Arbitrage is a strategy to profit from price differences between two or more markets.
In the early 1990s, many investors were caught off guard by a sudden rise in interest rates. Those who had invested in long-duration bonds experienced significant losses as the prices of these bonds fell sharply in response to the higher rates.
Which of the following measures the curvature of a bond's price-yield relationship?
A) Duration measures the sensitivity of a bond's price to changes in interest rates. B) Convexity measures the curvature of a bond's price-yield relationship. C) Yield to Maturity is the total return an investor will receive if a bond is held to maturity. D) Coupon Rate is the annual interest payment on a bond.
An investor is considering purchasing a 10-year bond with a duration of 7 years. If interest rates rose by 1%, the bond's price would fall by approximately 7%. Conversely, if interest rates were to fall by 1%, the bond's price would rise by about 7%.
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Example Series 65 Example Practice Question
$ *Duration*: Duration is a measure of the sensitivity of a bond's price to changes in interest rates. It is expressed in years and represents the weighted average time it takes to receive all cash flows from a bond. $ *Duration risk*: Duration risk refers to the potential for a bond's price to change due to fluctuations in interest rates. Bonds with longer durations are more sensitive to interest rate changes, resulting in greater price volatility.
$ *Duration*: A bond with a duration of 5 years means that, on average, it takes 5 years to receive all cash flows from the bond. If interest rates rise, the bond's price will decrease more than a bond with a shorter duration. $ *Duration risk*: An investor holding a bond with a long duration faces a higher risk of the bond's price decreasing if interest rates rise. Conversely, if interest rates fall, the bond's price will increase more than a bond with a shorter duration.