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

Accounting framework - convention of disclosure, Accounting Framework - Con...

Accounting Framework - Convention of Disclosure The doctrine of disclosure suggested in which all accounting statements should be honest and to that end, full disclosure of al

What is compound interest, What is compound interest? Compare compound inte...

What is compound interest? Compare compound interest to discounting. Compound interest takes place when interest is earned on interest and on the original principal of an inves

State the term- dividend cover, Dividend cover Dividend cover = Profit ...

Dividend cover Dividend cover = Profit available to ordinary shareholders (PAT) / Annual dividend(no. of times) Or =    EPS/Dividend per share Dividend cover shows safety

Estimate the npv of the project?, Wing Yin Tsui, CEO of Lian Huang & Wong B...

Wing Yin Tsui, CEO of Lian Huang & Wong Bin Dean Hwang Manufacturing Limited is considering a four year project. The project requires an initial investment of $10,000,000 to buy ne

Balance sheet equation concept, Balance Sheet Equation Concept The His...

Balance Sheet Equation Concept The Historical Cost Concept needs support of two other concepts for practical reasons, viz. (i) The Money Measurement Concept (already discus

Opperating cyles, discuss the applicability of operating cycles of vegetabl...

discuss the applicability of operating cycles of vegetable growing

Lockbox system, how do we compute for benefits can derrive out of using loc...

how do we compute for benefits can derrive out of using lockbox system?

What are the factors to consider in a takeover and merger, Factors to cons...

Factors to consider in a takeover/ merger Before a company decides to merge or acquire the following considerations should be taken: Rejection of bid by ta

Financial ratio , Ratio Calculation:   A 'Financial Ratio' is an ind...

Ratio Calculation:   A 'Financial Ratio' is an index that relates two accounting numbers and is obtained by dividing one number by the other. Various Ratios are - 1. L

Shareholders and auditors, agency relationship between shareholders and aud...

agency relationship between shareholders and auditors

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