Consider again the two bonds in problem 11.

If the investment goal is to leave the assets untouched until maturity, such as for a child’s education or for one’s retirement, which of the two bonds has more interest rate risk? What is the source of this risk?

Problem 11

Two 10-year bonds are being considered for an investment that may have to be liquidated before the maturity of the bonds. The first bond is a 10-year premium bond with a coupon rate higher than its required rate of return, and the second bond is a zero-coupon bond that pays only a lump-sum payment after 10 years with no interest over its life. Which bond would have more interest rate risk?

That is, which bond’s price would change by a larger amount for a given change in interest rates? Explain your answer.