Essays on How Changes in Interest Rates Would Affect Bond Prices Assignment

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The paper "How Changes in Interest Rates Would Affect Bond Prices " is a perfect example of a finance and accounting assignment. The price of a bond may go up and down in response to two factors: change in credit quality and interest rates. Investors in the bond market tend to worry about the safety of their investment. Many Australians who have invested in bonds do not comprehend how a change in the interest rate will have an effect on the bond price. Since the early 1980s, interest rates have been widely used to determine a return on bond investments.

The paper will use practical worked numerical examples to explain how changes in interest rates would affect bond prices (Amihud, 2002). Yield to Maturity (YTM) Yield to Maturity (YTM) (also known as redemption yield) is the most widely used measure of a bond’ s price. YTM of a bond can be described as the rate of return of a bond that an investor would receive if he or she bought a bond at the current market price, assuming the investor will hold onto his or her bond till it matures, and that all coupon and principal payments will be made on schedule (Ripley, 1997).

Contrary to a common belief that is often cited in financial literature that bond yield to maturity will not depend on reinvestment of dividends (Houweling, Mentink and Vorst, 2005). Rather, YTM is simply the discount rate at which the sums of all future cash flows from the bond (principal and coupons) are equal to the price of the bond (Temal, 2001). This measure of bond yield is often given in terms of APR (annual percentage rate).

Bonds yield have been seen to have different characteristics (Ripley, 1997), there are some variants of Yield to Maturity (YTM): Yield to call: the bond can be re-bought or repurchased by the issuer of the bond before it reaches maturity. Yield to put: same as yield to call, but it will depend on the person with the bond who has an option of selling the bond back to the issuer of the bond at a fixed price on a specified time or date.

References

Amihud, Yakov, 2002, Illiquidity and stock returns: cross-section and time-series effects,

Journal of Financial Markets 5, 31-56.

Houweling, Patrick, Mentink, Albert, and Vorst Ton, 2005, Comparing possible proxies of

corporate bond liquidity, Journal of Banking & Finance 29, 1331-1358

Park, S.-Y. and M. Reinganum, 1986, “The Puzzling Price Behavior of Treasury Bills that

Mature at the End of Calendar Months,” Journal of Financial Economics, 16, 267-283.

Ripley, William, 1997, Railroads: Finance & Organization. New York: Longmans, Green, &

Co.. pp. 106–107.

Temal, J. Wesalo, 2001, The Fundamentals of Municipal Bonds: The Bond Market

Association. John Wiley and Sons, Inc.. p. 49

O'Hara, Neil, 2012, The Fundamentals of Municipal Bonds. Hoboken, NJ: John Wiley & Sons,

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