Answer: Premium

## Explanation Interest rate risk refers to the sensitivity of a bond's price to changes in interest rates. This risk is measured by duration, with longer duration bonds having higher interest rate risk. ### Key Concepts: 1. **Duration**: Measures the sensitivity of a bond's price to interest rate changes 2. **Coupon effect**: Bonds with higher coupons have lower duration 3. **Price-yield relationship**: Premium bonds have higher coupons than discount bonds ### Analysis of Each Option: **A. Discount Bond**: - Sells below par value - Has coupon rate < market rate - Lower coupon payments → higher duration → higher interest rate risk **B. Premium Bond**: - Sells above par value - Has coupon rate > market rate - Higher coupon payments → lower duration → lower interest rate risk **C. Zero-coupon Bond**: - No coupon payments - All cash flows at maturity - Highest duration → highest interest rate risk ### Duration Comparison: - Zero-coupon bonds have the highest duration (equal to their maturity) - Discount bonds have higher duration than premium bonds of same maturity - Premium bonds have the lowest duration due to higher coupon payments ### Why Premium Bonds Have Lowest Interest Rate Risk: 1. Higher coupon payments mean investors receive cash flows sooner 2. Earlier cash flows reduce the bond's sensitivity to interest rate changes 3. The bond's price is less volatile when interest rates change **Correct Answer: B (Premium bond)** Premium bonds have the lowest interest rate risk because their higher coupon payments result in lower duration compared to discount and zero-coupon bonds of similar maturity.

Author: LeetQuiz .