chapter 6: bond valuation and interest rates part 2 Flashcards
are interest rates inversely related to bond prices?
yes
when bond prices increase what happens to interest rates?
interest rates decrease
when bond prices decrease what happens to interest rates?
interest rates increase
what are the factors affecting bond prices
the relationship between the coupon rate and bond’s yield to maturity (YTM) determines if a bond will sell at a
- premium
- discount or
- at par
if the coupon rate is greater than YTM
the price will be greater than face value
= discount
if the coupon rate = YTM
price will = Face value
at par
if the coupon rate is less than YTM
price is less than face value
premium
what are the factors affecting bond prices
1 . YTM
- time to maturity
- size of coupon
- interest rate risk and duration
- –
what affects to volatility of a bond
time to maturity and size of the coupon
when bond prices increase what happens to YTM
YTM decreases
when bond prices decrease what happens to YTM
YTM increases
what is the price-YTM relationship
it is convex
because the price -YTM relationship is convex, the price ….
rise due to a fall in YTM is greater than the price decline due to a rise in YTM given an identical change in YTM
for a given change in YTM, bond prices will change more when
interest rates are low than when they are high
what is volatility
Volatility is the pace at which prices move higher or lower,
Commonly, the higher the volatility, the riskier the security.
when speaking about time to maturity, which maturity bonds have a greater price volatility (long-maturity or short maturity)
long-maturity bonds
the longer the bond, the longer the period for which the cash flows are fixed
how does the size of the coupon affect the bond prices
low coupon bonds - have greater price volatility than higher coupon bonds
why are high coupon bonds les volatile than low coupon bonds
because they act like a stabilizing device
- since a greater proportion of the bond’s total cash flows occur closer to today and are therefore their present value is less affected by a change in YTM
the sensitivity of a bond’s price to change in interest rates is a measure of what
of the bond’s interest rate risk
interest rate risk is affected by what
- YTM
- term to maturity
- size of coupon
duration measure of interest rate risk
- as a change in price for a given change in interest rate
2. the higher the bond’s duration, the more sensitive its price is to changes in interest rates
a bond’s duration will be higher if its …….
YTM is lower
term to maturity is longer
coupon is lower
what is the quoted price
the price reported by the media
what is the cash price
the price paid by an investor, and includes both
1. the quoted price plus any interest that has accrued since the last coupon payment date
what is the YTM
it is the discount rate used for bond valuation
YTM is the yield an investor would earn if
- she purchases the bond at the current market price
- she holds the bond to maturity
- she reinvests all the coupons paid by the bond at the YTM
what is IRR
internal rate of return which is the YTM
ytm is therefore the bond’s
internal rate of return IRR
YTm is also the
discount rate that causes the PV of the bond’s future cash flows to equal its current price
how do you solve YTM
(2nd) (CLRTVM) 30 (PMT) - 1030 (PV) 1000 (FV) 40 (N) (CPT) (I/Y) =
then multiply by 2 to annualize
why do you enter the price as a negative number
because it is a cash outflow to purchase the bond
why do you enter the coupon and principal payments as positive numbers
these are cash inflows
