1. Explain: The market interest rate and price of bond sold in secondary markets is inversely...
1. Explain: The market interest rate and price of bond sold in secondary markets is inversely related.
2. Explain: Yield to maturity for a bond vs the stated interest rate on a bond.
Homework Answers
(1)
When market interest rate increases, the difference between the bond's coupon rate and market interest rate increases, making the bond less attractive. Therefore, bond sellers reduce the price of bonds to make them attractive enough to the investors for purchasing.
When market interest rate decreases, the difference between the bond's coupon rate and market interest rate narrows down, making the bond more attractive. Therefore, bond sellers increase the price of bonds to reap benefit from this attractiveness of the bond to investors.
Therefore, market interest rate and bond price are inversely related.
(2)
Stated interest rate on a bond remains unchanged during bond term. In contrast, yield to maturity (YTM) changes during this period. Bond YTM is the rate of return for which the discounted cash outflows (purchase price) equal the discounted cash inflows (annual coupon plus face value redeemed at maturity). YTM and bond price are inversely related.
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1. Explain: The market interest rate and price of bond sold in
secondary markets is inversely...
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