Question

The rate of return on a bond held to its maturity date is called the bond's yield to maturity.

If interest rates in the economy rise after a bond has been issued, what will happen to the bond's price and to its YTM? Does the length of time to maturity affect the extent to which a given change in interest rates will affect the bond's price? Why or why not? If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.

Answer 1

If interest raise rise, the price of bond will fall as its YTM will rise because it will provide return equal to comparable risk investments.

Greater the time to maturity more will be the decrease in bond price due to increased rates. It will happen because the coupons and face value shall be discounted for a larger number of time period and therefore shall have less value due to more discounting.

Callable bond shall be recalled by the issuer if the price rises too much due to falling rates. It is so because issuer will issue new bonds at a lower interest rates in lieu of them. Hence value of callable bond shall not rise more thna the value at which they become callable.