Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the LARGEST percentage increase in price?

a. an 8-year bond with a 9% coupon

b. a 1-year bond with a 15% coupon

c. a 3-year bond with a 10% coupon

d. a 10-year zero coupon bond

Answer:

The bond whose duration will be the highest will have the largest increase in the price and the duration of the bond is affected by the following:

Time to maturity: The shorter-maturity bond would have a lower duration and less price risk. The longer the maturity, the higher is the duration.

Coupon rate: The higher the coupon, the lower is the duration.

Therefore, 10 year bond will be having highest duration. Among all 10 year bond, a bond with lower coupon will have highest duration. Thus 10 year bond with zero coupons will be having highest duration.

Hence, the correct option is D.