Price-yield relationship in bonds, Financial Management

Assignment Help:

Typically in a bond, we find an inverse relation between the price and the required yield. We know that the price of the bond is the present value of cash flows. If the required yield increases, the present value of the cash flow declines and hence the bond value also declines. Let us compute the relationship between the price and the required yield for a bond with a coupon rate of 10% with par value of Rs.100 maturing after 10 years for different required yields as per the table given below:

Table 1: Price-Yield Relationship

Yield (in %)

Price in Rs.

  4

148.70

  6

129.40

  8

113.40

10

100.05

12

   88.70

14

   79.16

16

   71.53

18

   64.04                                          

          Figure 1: Price/Yield Relationship for an Option Free Bond

1005_price yield relationship.png

 

If we plot a graph the price-yield relationship, we get a convex curve as seen above in the graph. This convexity has important implications with investment characteristics of a bond. Whenever yields in the market change, the bond prices also change to compensate the yield expectations of the investor. For example, if the coupon rate of a bond is 11% and the present market coupon rate for similar bonds is 12%, then the bond value gets depleted as it yields only 11% as against the current market yield of 12%. Conversely, if the current market yield is 9.5%, then the bond gets traded at premium as the bond under reference gives an yield of 11% as against the current yield of 9.5%. When the bond is sold below par value, then it is said to be sold at a discount. When the bond is sold above par value, it is said to be traded at a 'premium'. It can be summed up as follows:

Coupon rate = Required yield then price = Par value

Coupon rate < Required yield then price < Par (discount)

Coupon rate > Required yield then  price > Par (premium).


Related Discussions:- Price-yield relationship in bonds

Bonds with embedded put options, Put option is the right of the inves...

Put option is the right of the investor which he may exercise on the date at the put price given in the indenture. Normally, put price is in par value. When yield rises

Swiss variable rate mortgage, A Swiss Variable Rate Mortgage (S...

A Swiss Variable Rate Mortgage (SVRM) is a version of ARM which carries a coupon rate that a bank can change any time giving a notice of three m

Interpretations of short term solvency or liquidity ratio''s, Short Term So...

Short Term Solvency or Liquidity Ratio's   CR:          The Current Ratio is calculated by current assets to current liabilities and is the index of company's financial stab

Explain about invoice discounting, Q. Explain about Invoice discounting? ...

Q. Explain about Invoice discounting? Invoice discounting is a technique which is able to be used to raise finance against receivables. Invoice discounting works as follows:

Have large bank holding companies increased market share, Have the large ba...

Have the large bank holding companies increased their market share at the expense of smaller institutions? A: No. A study conducted by the Federal Reserve Bank of New York reve

Define correlation coefficient for two variables is -1, What does it mean w...

What does it mean when we say that the correlation coefficient for two variables is -1? What does it mean if this value were zero? What does it mean if it were +1? Correlation is

Geographical classification of mutual funds , Geographical Classification o...

Geographical Classification of Mutual Funds : Nations' boundaries provide territorial restrictions on the sale and purchase of mutual fund units or shares as is the case in com

Define a callable bond, What is a callable bond?  What is a putable bond?  ...

What is a callable bond?  What is a putable bond?  How do each of these features affect their respective market interest rates? A callable bond may be retired untimely at the dis

Define defined benefit and defined contribution pension plan, Compare and c...

Compare and contrast a defined benefit and a defined contribution pension plan. In a defined benefit plan, retirement benefits are defined by a formula that generally considers t

13 basic ratios, What its the net income? Total current assets, plant and e...

What its the net income? Total current assets, plant and equipment, net plant and equipment, our net account receivable?

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd