Bonds

Last updated Nov 8, 2022 Edit Source

Callability: Issuer can redeem the bond before maturity leads to higher risk to the investor, will mean that the bond will have **relatively higher YTM.

Putability: Buyer can redeem the bond before maturity leads to higher risk to the issuer, will mean that the bond will have **relatively lower YTM.

The relationship between bond prices and interest rates When interest rate increases, people are able to obtain bonds with higher YTM, this makes the current bond which offers a lower YTM worth less: becomes a discount bond. Vice versa for when interest rates decreases

Price Relationships

• Higher coupon payments will have less sensitivity to changes in interest rates
• Longer maturities will have higher sensitivity to interest rate changes
• Riskier bonds ($\beta\\ is\\ higher\\ hence\\ r_e$ is higher) will have lower price

The expected return if one was to hold the bond till maturity

YTM is different from EAR 8% semi-annual coupon bond selling at par will have $EAR=(1+0.04)^2-1=8.16%$ but will have a YTM of 8%

A bond that has same risk and term as the above, but pays annual coupons instead will have a YTM of 8.16%

Depends only on the maturity and risk. If these are the same across 2 bonds, they will have the same effective yield with differing coupon payments.

$$ Current\\ Yield=\frac{Annual\\ Interest\\ Payments}{Current\\ Bond\\ Price} $$ Zero coupon bonds: Bonds which give out no coupons

• Current yield = 0

For all par bonds: $$YTM=Current\\ Yield=Coupon\\ Rate$$ For all discount bonds: $$YTM>Current\\ Yield> Coupon\\ Rate$$ For all premium bonds: $$YTM<Current\\ Yield< Coupon\\ Rate$$

Inflation premium: reflects the health of the economy. Investors expect inflation to rise in an economy that is doing well. Real rate: does not affect the slope of the curve, only translates the curve.