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

Walter''s model, 3. The following information are related to Sun Ltd. Paid...

3. The following information are related to Sun Ltd. Paid-up equity capital ` 10,00,000 Earnings of the company ` 1,00,000 Dividend paid ` 80,000 Price - Earning rat

Show the compound value of the single flow, Q. Show the Compound Value of t...

Q. Show the Compound Value of the Single Flow ? Compound Value of the Single Flow (Lump Sum):- The process of computing future value becomes very cumbersome if they have to be

Available bid capacity for a bidder, A vailable bid capacity We saw th...

A vailable bid capacity We saw the criterion that qualifies the bidder. Now we will learn about the bid capacity. There are chances that a bidder might acquire more contrac

Multi-period compounding or else future value, Multi-period Compounding or ...

Multi-period Compounding or else Future Value :- If the company determination compounding interest half-yearly (semi-annually) instead of annually then investors will gain as he wi

Walter''s Model, Explain the effect of different dividend policies on the v...

Explain the effect of different dividend policies on the value of share respectively as per the walter model in Case 1: Dividend payout ratio is 50% Case 2: Dividend payout ratio

Discuss how a firm can maintain adequate working capital, Question 1 An...

Question 1 Analyse the financial requirements of a FMCG company 2 If you are an investor and are interested in finding out the value of an amount of Rs 10,000 to be received

Capital Strructure., What is the rational for having different types of sec...

What is the rational for having different types of security

Rationale for mergers-product advantages, Product Advantages: A firm th...

Product Advantages: A firm that has developed a reputation for superior products in the domestic market may find acceptance from the foreign consumers as well. Hence, such firm

What is bridge financing, Bridge Financing A type of short-term financ...

Bridge Financing A type of short-term financing used to cover an organization short-term want; a loan that is expected to be repaid relatively fast.

Evaluate alternative hedging strategies, Peak Inc. needs to order Canadian ...

Peak Inc. needs to order Canadian raw materials to use in its production process. The Canadian exporter typically invoices Peak in Canadian dollars. Assume that the current exchang

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