Certified Plan Sponsor Professional (CPSP) Practice Exam

What is one of the primary risks associated with long-duration bonds?

1. Higher credit risk.

2. Lower liquidity.

3. Interest rate risk is greater compared to short-duration bonds.

4. No risk of default.

The correct answer is: Interest rate risk is greater compared to short-duration bonds.

The primary risk associated with long-duration bonds is interest rate risk being greater compared to short-duration bonds. This is because the prices of long-duration bonds are more sensitive to changes in interest rates. When interest rates rise, the market value of existing bonds typically falls, and the longer the duration of the bond, the more pronounced this effect. For long-duration bonds, the impact of interest rate fluctuations over a more extended period can lead to significant price volatility. As investors demand higher yields when interest rates increase, existing bonds with lower rates become less attractive, resulting in a decline in their market value. Thus, long-duration bonds present a heightened risk in a rising interest rate environment, making this risk a critical consideration for investors managing bond portfolios.