Examkin

Question

Difficulty: EasyDebt Securities and Bond Structure

An investor holds a U.S. Treasury bond. Although the bond carries virtually zero default risk because it is backed by the full faith and credit of the U.S. government, the market value of the bond decreases when market interest rates rise. Which type of risk does this scenario best describe?

  1. Interest rate riskAnswer
  2. B
    Credit risk
  3. C
    Liquidity risk
  4. D
    Inverted yield curve risk

Answer

Interest rate risk
Interest rate risk is the risk that an existing fixed-income security's market price will decline when prevailing interest rates rise. Even securities backed by the U.S. government with zero default risk are subject to interest rate risk.

Step-by-Step Solution

1
Identify the primary driver of market value changes in the scenario.
The bond's price declines as prevailing interest rates increase.
Bond prices and interest rates share an inverse relationship.
2
Differentiate between credit risk and market/interest rate risk.
U.S. Treasury bonds possess virtually zero default (credit) risk, so price changes stem entirely from market interest rate shifts.
Interest rate risk affects all fixed-income securities regardless of the issuer's credit quality.

Key Concept

Interest Rate Risk vs. Credit Risk
Rate this question

Topics

Debt Securities and Bond Structure

More questions from this topic