What typically happens to the price of bonds with the longest maturities when interest rates decrease?

What typically happens to the price of bonds with the longest maturities when interest rates decrease?

• A. They decrease in value
• B. The price remains constant
• C. They increase in value more significantly
• D. Their price increases less than short-term bonds

Answer: (C)

When interest rates decrease, the prices of bonds generally rise, and this effect is more pronounced for bonds with longer maturities. The reason for this is that longer-term bonds have a greater duration, which means they are more sensitive to changes in interest rates. As interest rates fall, investors seek to lock in the higher coupon rates offered by existing bonds, particularly those with longer maturities, since they will continue to receive these higher payments over a longer period. This increased demand for long-term bonds drives their prices up more significantly than those of short-term bonds. In contrast, short-term bonds are less affected by interest rate changes because they are closer to maturity and thus have less time for the changes in rates to impact the total return on the bond. Therefore, while all bonds generally increase in price when interest rates decrease, long-term bonds provide a greater percentage increase due to their higher sensitivity to interest rate movements.

When interest rates decrease, the prices of bonds generally rise, and this effect is more pronounced for bonds with longer maturities. The reason for this is that longer-term bonds have a greater duration, which means they are more sensitive to changes in interest rates.

As interest rates fall, investors seek to lock in the higher coupon rates offered by existing bonds, particularly those with longer maturities, since they will continue to receive these higher payments over a longer period. This increased demand for long-term bonds drives their prices up more significantly than those of short-term bonds.

In contrast, short-term bonds are less affected by interest rate changes because they are closer to maturity and thus have less time for the changes in rates to impact the total return on the bond. Therefore, while all bonds generally increase in price when interest rates decrease, long-term bonds provide a greater percentage increase due to their higher sensitivity to interest rate movements.