Question

G. The relationship between bond prices and yields is very important to fixed-income investors. Explain the characteristics of a bond that affect its price volatility.

Answer 1

The relationship between the bond price and yield is very important from the point of view of fixed income investors because this will determine their capital gain or loss if they are closing their position prior to the maturity of the bond. There is an inverse relationship between the bond price and the yield on the bond. If the yield on the bond rises the bond price falls and if the yield on the bond falls the bond price rises. It is also known as interest rate risk; interest rate risk is measured by duration. It is an approximate measure as to how much percentage change in yield will result in how much percentage change in price of the bond. So,

percentage change in price = - Modified duration * change in yield