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Bond prices over time

The relationship between interest rates and bond
prices
•

Premium Bond

–
–
–
•

Coupon rate exceeds yield to maturity
Bond price will decline to par over its maturity

Discount Bond

–
–
–

•

price > par

price < par
Yield to maturity exceeds coupon rate
Bond price will increase to par over its maturity

Bond selling at par

–
–
–

price = par
Yield to maturity = coupon rate
bond price is constant throughout the life of bond

Bond Value ($)
1,372

rd= 7%.

1,211

1,000

rd= 10%.

M

837

rd= 13%.
775

30

25

20

15

10

5

0

Years remaining to Maturity

Yeildto maturity versus Holding-Period return

•
•

When the yield to maturity is unchanged over the period, the rate of
return on the bond will equal that yield
Example:Face value = $1000, Annual coupon payment = $70

Interest rate = 8%

Maturity
P= $974.23

P=$982.17

 

•

When the yields fluctuate, a bond ‘s rate of returns will fluctuate

 An increase in the bond’s yield to maturity acts to reduce its price, which means that the
holding-period return will be less than the initial yield

 An decline in the bond’s yield to maturity results in the holding-period return greater
than the initial yield

•

Example: Face value = $1000

Annual coupon payment = $80

YTM = 8%

YTM falls

P= $1000

P= $1050

 

Zero-coupon

•

Zero coupon bond carries no coupons and provides all its return in the
form of price appreciation.

Treasury STRIPS

•
•
•

A Treasury security in which the periodic interest coupon
payment can be separated from the each other and from the
final principal payment
For example, a Treasury note with 10 years remaining to maturity consists of a single
principal payment at maturity and 20 interest payments, one every six months for 10
years. When this note is converted to STRIPS form, each of the 20 interest payments
and the principal payment becomes a separate security.
STRIPS are also called zero-coupon securities because the only time an investor
receives a payment during the life of a STRIP is when it matures.

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