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Class 10 Completed

Prior to maturity the price of the bond gradually

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Prior to maturity, the price of the bond gradually increases so that coupon payment and built-in price appreciation result in a 10% return (assuming no further changes in interest rates).
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21 Important Insights: Market Rates and Bond Prices N When the interest rate used to discount a bond s cash flows (the ytm) increases, the price of the bond decreases. At a higher discount rate, the present value of the payments to be received by the bondholder is lower. Therefore, bond prices will fall as market interest rates rise. N This illustrates a crucial general rule in bond valuation: When interest rates rise, the prices for existing bonds must fall. The reason for this is that the present value of the bond s payments to be received is lower when the discount rate is higher. N Of course the opposite happens when market interest rates fall N The inverse relationship between price and yield is a central feature of fixed-income securities. Interest rate fluctuations and the resulting capital gains or losses (changes in the value, especially of longer-term bonds) represent the main source of risk in the fixed-income markets.
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