Question

Using the duration and yield information in the table below, briefly compare how the prices would move of the two HIGH YIELD bonds if you expect:

	Bond A (Callable)	Bond B (non-callable)
Maturity	2025	2025
Coupon	11.50%	7.25%
Current Price	125.75	100.00
Yield to maturity	7.70%	7.25%
Modified duration to maturity	6.20	6.80
Call date	2014
Call price	105
Yield to call	5.10%
Modified duration to call	3.10
Moody's Rating	Ca	Caa

a. Strong economic recovery with rising inflation expectations:

b. Economic recession with reduced inflation expectations:

Answer 1

For inflationary environment, we expect interest rates (market) to raise. This reduces the price of both the bonds. Rate of reduction depends on Duration. For Bond A, for 1% increase in market yield , price of bond decreased by 6.2%. similarly for Bond B the decrease in bond price is 6.8% for every 1% increase in market yield. In the second scenario , with reduced inflation, exact reverse scenario occurs. With reduction in market yields, bond prices raise according to their duration. For Bond A it is a 6.2% increase in bond price for every 1% decrease in market yield and similarly this figure is 6.8% for bond B.