Why might a conservative investor prefer to invest in more short-term bonds rather than long-term bonds?

• A. Long-term bonds are more liquid than short-term bonds.
• B. Short-term bonds always offer higher yields than long-term bonds.
• C. Short-term bonds generally have lower interest rate risk compared to long-term bonds.
• D. Short-term bonds are not affected by changes in market interest rates.

Answer: (C)

Verified step by step guidance

1. Understand the concept of interest rate risk: Interest rate risk refers to the risk that the value of a bond will decrease due to changes in market interest rates. Long-term bonds are more sensitive to these changes because they lock in a fixed interest rate for a longer period.
2. Recognize the relationship between bond maturity and interest rate risk: Short-term bonds generally have lower interest rate risk because their maturity is closer, meaning they are less affected by fluctuations in market interest rates over time.
3. Evaluate the liquidity of bonds: While long-term bonds may sometimes be more liquid, this is not always the case. Liquidity depends on market demand and other factors, not just the bond's maturity.
4. Understand yield differences: Short-term bonds do not always offer higher yields than long-term bonds. Yield is influenced by various factors, including the bond's credit rating, market conditions, and the issuer's financial health.
5. Conclude why a conservative investor might prefer short-term bonds: A conservative investor typically seeks to minimize risk. Since short-term bonds have lower interest rate risk, they are often preferred by investors who prioritize stability and risk reduction over potentially higher returns from long-term bonds.