value of outstanding bond changes whenever the going rate of interest changes in general short term interest rates are more volatile than long term interest rates. therefore short term bond prices are more sensitive to interest rate changes than are long term bond prices.is this statement true or false? explain.
value of outstanding bond changes whenever the going rate of interest changes in general short term interest rates are more volatile than long term interest rates. therefore short term bond prices are more sensitive to interest rate changes than are long term bond prices.is this statement true or false? explain.
This statement is true. Short term bond prices are indeed more sensitive to interest rate changes compared to long term bond prices. To understand why this is the case, let's break down the explanation:
1. Relationship between bond prices and interest rates:
When interest rates rise, the value of existing bonds decreases, and when interest rates fall, the value of existing bonds increases. This inverse relationship is due to the fact that newly issued bonds will offer higher yields in a rising interest rate environment, making existing lower-yielding bonds less attractive.
2. Sensitivity to interest rate changes:
The relationship between bond prices and interest rates becomes clearer when we consider the concept of bond duration. Duration measures the weighted average of the time it takes for an investor to receive the bond's cash flows (coupon payments and principal repayment). It is a useful measure for estimating the price change of a bond for a given change in interest rates.
3. Short term bond duration:
Short term bonds have shorter durations compared to long term bonds. This is because they have a shorter time period until their maturity date, and, as a result, they have fewer future coupon payments to factor in. Therefore, the price of a short term bond will be less affected by changes in interest rates compared to a long term bond.
4. Volatility of short term interest rates:
In general, short term interest rates tend to be more volatile or susceptible to frequent changes compared to long term interest rates. Short term rates are often influenced by economic indicators, central bank policies, and market expectations, leading to more frequent fluctuations. On the other hand, long term interest rates are influenced by broader economic factors, inflation expectations, and market sentiment, resulting in relatively less volatility.
Combining these factors, we can conclude that short term bond prices are more sensitive to interest rate changes given their shorter duration and the higher volatility of short term interest rates. In contrast, long term bond prices are relatively less affected due to their longer durations and the smoothing effect of long term interest rates.