Response to the following problem:
Stacy is an aggressive bond trader who likes to speculate on interest rate swings. Market interest rates are currently at 9%, but she expects them to fall to 7% within a year. As a result, Stacy is thinking about buying either a 25-year, zero-coupon bond or a 20-year, 7.5% bond. (Both bonds have $1000 par values and carry the same agency rating.)
Assuming that Stacy wants to maximise capital gains, which of the two issues should she select? What if she wants to maximise the total return (interest income and capital gains) from her investment? Why did one issue provide better capital gains than the other?
Based on the duration of each bond, which one should be more price volatile?