"Short-term interest rates are more volatile than long-term...

Name: Problem 2, Chapter 5: Financial Management: Theory & Practice
Uploaded: 2023-08-14T00:50:35-08:00
Duration: 3 min 7 s
Channel: Jennifer Stoner
Description: "Short-term interest rates are more volatile than long-term interest rates, so shortterm bond prices are more sensitive to interest rate changes than are long-term bond prices." Is this statement true or false? Explain.

"Short-term interest rates are more volatile than long-term interest rates, so shortterm bond prices are more sensitive to interest rate changes than are long-term bond prices." Is this statement true or false? Explain.

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Key Concepts

Duration

Duration is a measure of a bond’s sensitivity to changes in interest rates. It captures the weighted average time until the bond’s cash flows are received and is a key determinant of how much a bond's price will change when interest rates change. Bonds with longer maturities generally have longer durations and therefore exhibit more price sensitivity to interest rate changes than bonds with shorter maturities.

Interest Rate Volatility

Interest rate volatility describes the degree of fluctuation in interest rates over time. Short-term interest rates often experience higher volatility due to factors like central bank policy adjustments and market conditions. However, this volatility does not directly imply that the prices of short-term bonds are more sensitive to interest rate changes, as bond price sensitivity is more closely related to duration.

Interest Rate Risk

Interest rate risk refers to the risk that changes in interest rates will negatively affect a bond's price. While short-term interest rates may be more volatile, the actual price risk of a bond depends largely on its duration. Longer-term bonds, with higher durations, typically face greater interest rate risk despite long-term rates being less volatile on average.

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