Some institutional investors prefer zero coupon bonds over coupon bonds of the same maturity (and same quality). They will ever purchase a lower YTM zero coupon than the same maturity coupon bond. Which statement below best describes why they do this? (Points: 4)
Coupon payments every 6 months can be reinvested in an efficient manner.
Coupon bonds have less reinvestment risk than zero coupon bonds.
zero coupon bond have no reinvestment risk.
This is the best math formula we have; and universally accepted.
All of the above statements are correct.
The correct answer is: "Coupon payments every 6 months can be reinvested in an efficient manner."
Institutional investors prefer zero coupon bonds over coupon bonds because they can reinvest the coupon payments from a coupon bond in a more efficient manner. When a coupon bond pays periodic interest payments, such as every 6 months, the investor receives those payments and can invest them again immediately. By continuously reinvesting the coupon payments, the investor can potentially earn higher returns.
On the other hand, zero coupon bonds do not make periodic interest payments. Instead, they are issued at a discount to their face value and provide a lump sum payment at maturity. Since there are no intermediate coupon payments to reinvest, there is no reinvestment risk associated with zero coupon bonds.
To get the answer to this question, it is important to understand the characteristics of zero coupon bonds and coupon bonds, as well as the concept of reinvestment risk. Zero coupon bonds and coupon bonds have different cash flow structures, and institutional investors have a preference for zero coupon bonds due to their lack of reinvestment risk.