2. Relationships between Bond Price and Bond Characteristics
b. identify the relationships among a bond's price, coupon rate, maturity, and market discount rate (yield-to-maturity);
c. define spot rates and calculate the price of a bond using spot rates;
How is the value of a bond determined?
The value of a bond is equal to the present value of its coupon payments plus the present value of the maturity value.
How does the discount rate affect the value of a bond?
The higher the discount rate, the lower a cash flow's present value and therefore since the value of a security is the present value of the cash flows, the higher the discount rate, the lower a security's value.
What is positive convexity?
For a large change in interest rates, the amount of price appreciation is greater than the amount of price depreciation.
For bonds, what is the maturity effect?
The longer the term to maturity, the greater the price volatility.
For bonds, what is the coupon effect?
The lower the coupon rate, the greater the price volatility.
How does the passage of time impact the value of a bond selling at premium/discount/par?
The bond value
- decreases over time if the bond is selling at a premium
- increases over time if the bond is selling at a discount
- is unchanged if the bond is selling at par value
What is "pull to par value"?
At the maturity date, the bond's value is equal to its par value
What is the arbitrage-free approach to valuing a bond?
The arbitrage-free approach values a bond as a package of cash flows, with each cash flow viewed as a zero-coupon bond and discounted at its own unique discount rate.