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When the level of market interest rates is anticipated to fall (select the best answer):
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B. callable bonds with small coupons and the longest time to maturity have the greatest potential for price appreciation
C. option-free bonds with small coupons and the longest time to maturity have the greatest potential for price appreciation
Answer: C
Explanation:
A bond's time to maturity is positively related to the elasticity of the bond's price with respect to changes in its required return. A bond's coupon rate is inversely related to the elasticity of the bond's price with respect to changes in its required return. The upside potential of a reduction in required return is less for a callable bond than for a similarly defined option-free bond.
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