42. Which of the following instruments has the greatest change in price for a 1% change in the general level of interest rates?
Answer: C
The 30-year zero coupon bond has the greatest change in price for a 1% change in the general level of interest rates.
Zero coupon bonds, such as the 30-year zero coupon bond, have no periodic interest payments and are sold at a discount to their face value. This structure makes their prices more sensitive to changes in interest rates compared to other instruments.
A) 3-month Treasury bill
The 3-month Treasury bill is a short-term debt instrument that typically exhibits less price volatility in response to interest rate changes. Due to its short maturity, its price is less sensitive to interest rate movements compared to longer-term securities.
B) 10-year Treasury note
While the 10-year Treasury note has greater sensitivity to interest rate changes than shorter-term instruments, it still does not match the price volatility of a 30-year zero coupon bond. The longer duration of the zero coupon bond amplifies its price fluctuations in response to interest rate changes.
C) 30-year zero coupon bond
The 30-year zero coupon bond is highly sensitive to changes in interest rates because it does not pay periodic interest and its entire return is realized at maturity. This characteristic results in a significant change in price for even a small change in interest rates, making it the instrument with the greatest price change.
D) 30-year callable municipal bond
A 30-year callable municipal bond may offer some sensitivity to interest rate changes, but callable features can limit price appreciation when rates fall. Additionally, its structure does not provide the same level of sensitivity to interest rate changes as a zero coupon bond, particularly over a long duration.
Conclusion
The 30-year zero coupon bond is the correct answer as it demonstrates the greatest price change in response to shifts in interest rates due to its lack of periodic interest payments and long duration. In contrast, the other options either have shorter maturities or structural features that reduce their sensitivity to interest rate fluctuations, making them less responsive than the zero coupon bond.