Question

A 10 year bond with annual coupons has face value 500 units and coupon rate of two
per cent. Because the bond is seen as a “safe refuge”, during uncertain times the
price is bid up.
a) Calculate by how much the (second hand market) price would need to rise to
in order for the yield received by a purchaser to fall to zero.
b) If the bond had no coupons what yield would be the result of an increase in its
second hand market price by 50%?
c) If, instead, the bond had only coupons (a perpetuity), what price would drive
the yield to zero? What yield would emerge from an increase in its second
hand market price by 50%?
d) Briefly explain the contrasts in yield behaviour between non-coupon bonds,
coupon bonds with short maturities, coupon bonds with finite but long
maturities and perpetuities. Explain which type is most likely to have negative
yields and why?
e) Briefly explain why, when yields actually go negative, they do so by small
amounts

Answer 1

(A)

(B)

(C)

(D) It is difficult to compare two bonds in rupee terms hence we compute yield to maturity to have efficient comparison.There are different methods to compute yield for different type of bonds as per their tenure,coupon payments etc.Yield is different in cases as shown above this is due to different behaviour of bonds as per there nature.Yield is inversely propotional to price of bond therefore as price rises bond yield falls and vice versa.Yield is high in coupon bonds as compared to ZCB and perpetuity.Yiled is high in ZCB then perpetuity.

The perpetuity bond gives the highest negative yield because of highest price of bond.

(E)Yield go negative because it is inversely propotional to price of bond therefore when price rises by any amount yield will fall and vice versa and that is also by small amount because it is long term bond having maturity period of 10 years therefore the longer the maturity the change will be inverse to price but will be in small amount.