FIN-2Lecture 9-The Term Structure of Interest Rates and Yield Derivation

# Sensitive to interest rate changes than prices of

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Unformatted text preview: s yield to maturity results in a smaller price change than a decrease in yield of equal magnitude Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds The sensitivity of bond prices to changes in yields increases at a decreasing rate as maturity increases . In other words, interest rate risk is less than proportional to bond maturity Interest rate risk is inversely related to the bond’s coupon rate. Prices of high coupon bonds are less sensitive to changes in interest rates than prices of low coupon bonds The sensitivity of a bond’s price to a change in its yield is inversely related to the yield to maturity at which the bond is currently selling Factors Affecting Yield Spreads § Municipal bond rates are usually 20-30% lower than corporate bonds due to tax-exempt feature § Treasury bonds have lower rates than corporate bonds due to no default risk § The lower the credit rating (and higher the risk), the higher the interest rate § Discount (low-coupon) bonds yield less than premium (high-coupon) bonds Factors Affecting Yield Spreads § Revenue muni bonds yield more than general obligation muni bonds due to higher risk § Freely callable bonds yield higher than non-callable bonds § Bonds with longer maturities generally yield more than shorter maturities Investors’ Bond Pricing § § § Earlier we discussed coupon bonds and Zero-coupon Bonds We also said that bonds with different maturities will sell at different yields – long-term bonds = higher yield; and vice versa Consider the following zero-coupon bonds with face value Maturity Years Yield Price FVn x [(1+y)-n] (RRR) €1,000 1 5% 1000 x 1.05-1 €952.38 2 6% 1000 x 1.06-2 €889.99 3 7% 1000 x 1.07-3 €816.30 §We 4 borrow this 8% concept and apply€it to coupon bonds 1000 x 735.03 1.08-4 §Investors consider each coupon payment (cash flow) as at least potentially sold off separately as a stand-alon...
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## This note was uploaded on 05/03/2013 for the course FIN 101 taught by Professor Mugabi during the Spring '13 term at De Haagse Hogeschool.

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