Question

Consider the following bonds: A. What is the percentage change in the price of each bond if its yield to maturity falls from 6% to 5%? B. Which of the bonds A–D is most sensitive to a 1% drop in interest rates from 6% to 5% and why? Which bond is least sensitive? Provide an intuitive explanation for your answer.

A. Bond price sensitivity analysis
B. Yield to maturity impact on bond prices
C. Evaluating bond performance under interest rate changes
D. Understanding bond price fluctuations

Answer 1

The price of a bond is inversely related to its yield to maturity. A decrease in yield to maturity leads to an increase in bond prices. Bonds with longer maturities have higher price sensitivity to interest rate changes compared to bonds with shorter maturities. Bond prices are affected by changes in interest rates.

Step-by-step explanation:

Bond price sensitivity analysis:

The price of a bond is inversely related to its yield to maturity. When the yield to maturity decreases, the price of the bond increases.

Yield to maturity impact on bond prices:

A decrease in yield to maturity leads to an increase in bond prices. The percentage change in price can be calculated using the formula:

Price change percentage = (Yield to maturity change percentage) x Modified duration

Evaluating bond performance under interest rate changes:

Bonds with longer maturities have higher price sensitivity to interest rate changes compared to bonds with shorter maturities. This is because longer maturity bonds have higher modified durations, which amplifies price changes.

Understanding bond price fluctuations:

Bond prices are affected by changes in interest rates. When interest rates decrease, bond prices increase, and vice versa.