Which statement about zero-coupon bonds is true?

• A. They are more sensitive to interest rate changes than coupon bonds
• B. They pay periodic coupons
• C. They have lower duration
• D. They are unaffected by interest rate changes

Answer: (A)

Zero-coupon bonds carry all their value at one future date, with no interim coupon payments. That means their price today is just the face value discounted back by the current yield, P = F / (1+i)^t. The sensitivity of price to changes in the yield is driven by duration, which for a zero-coupon bond is essentially the time to maturity. Since there are no earlier cash flows to cushion rate moves, the duration is high, so even small changes in interest rates cause larger percentage moves in price than a coupon-bearing bond of the same maturity. This is why zero-coupon bonds are more sensitive to interest-rate changes.

They don’t pay periodic coupons, so that part is false. They don’t have lower, but higher duration compared with coupon bonds of the same maturity, so that is false as well. And they are not unaffected by rate changes—price will move with changes in yields.