Question

When investors doubt the creditworthiness of a borrower, what should happen to the price and yield of the bond? 

• Price goes down, yields go up 

• Price goes up, yields go down 

• Price goes down, yields go down 

• Price goes up, yields go up

Answer 1

The correct answer is

Prices go down, yield go up

There is inverse relationship between the price of bond and its yield and as the creditworthiness comes in doubt, it reduces the price of bond and will increase the yield simultaneously. Let try to understand the same with the below mentioned example :-

Suppose an investor purchases a bond that matures in 10 years with a 8% annual coupon rate and a face value of $100. If interest rates rise above 8% and if the investor decides to sell it bond's price will fall as it makes bond unattractive as compare to other higher interest paying bonds/ instruments.

If the bond owner wants to sell the bond, the price can be lowered so that the coupon payments and maturity value equal yield to compensate the higher interest rate as per the concept of time value of money and thus investor has to drop the price.
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