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

Show gross vs net working capital, Q. Show Gross Vs net working capital? ...

Q. Show Gross Vs net working capital? The distinction between the gross working capital or the net working capital does not in any way undermine the relevance of the concepts o

Calculate the rate of return, A Life Insurance Company invested $10,000,000...

A Life Insurance Company invested $10,000,000 in pure-discount U.S. bonds in May 1995 while the exchange rate was 80 yen per dollar. The insurance company liquidated the investment

Investor’s considerations -financial market, Investor's Considerations ...

Investor's Considerations As mentioned above, every investor before taking an investment decision, must consider the following aspects: Risk: The primary consideration for t

Concept of yield measures, A fixed income security investor can expect to r...

A fixed income security investor can expect to receive a rupee returns from the following sources: (a) Interest payment, (b) Capital gain or loss at maturity or when so

T - account of the banking system - equilibrium, Suppose that the Fed buys ...

Suppose that the Fed buys $1 million of bonds from the First National Bank. If the First National Bank and all other banks use the resulting increase in reserves to purchases bonds

Does high operating leverage always mean high business risk, Does high oper...

Does high operating leverage always mean high business risk?  Explain. High operating leverage does not all the time mean high business risk.  If the companies sales are quite

Create a report that fully explains both directors views, The Directors of ...

The Directors of Rohan Plc are discussing the importance of the dividend policy on the market value of their firm. The Chairman considers that the dividend is important and does a

Define decision to not permit price to ration goods, What reasons do govern...

What reasons do governments frequently give to justify the decision to not permit price to ration goods? (a) Price gouging is bad. (b) Income is unfairly distributed. (c) Some

Risk and advantages associated with company locations, What are some of the...

What are some of the primary advantages when a corporation has operations in countries other than its home country?  What are some of the risks? Foreign operations may decrease

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