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Charles J. Corrado_Fundamentals of Investments - Chapter 10

CHAPTER 10 Bond Prices and Yields Interest rates go up and bond prices go down. But which bonds go up the most and which go up the least? Interest rates go down and bond prices go up. But which bonds go down the most and which go down the least? For bond portfolio managers | CHAPTER 10 Bond Prices and Yields Interest rates go up and bond prices go down. But which bonds go up the most and which go up the least Interest rates go down and bond prices go up. But which bonds go down the most and which go down the least For bond portfolio managers these are very important questions about interest rate risk. An understanding of interest rate risk rests on an understanding of the relationship between bond prices and yields In the preceding chapter on interest rates we introduced the subject of bond yields. As we promised there we now return to this subject and discuss bond prices and yields in some detail. We first describe how bond yields are determined and how they are interpreted. We then go on to examine what happens to bond prices as yields change. Finally once we have a good understanding of the relation between bond prices and yields we examine some of the fundamental tools of bond risk analysis used by fixed-income portfolio managers. 10.1 Bond Basics A bond essentially is a security that offers the investor a series of fixed interest payments during its life along with a fixed payment of principal when it matures. So long as the bond issuer does not default the schedule of payments does not change. When originally issued bonds normally have maturities ranging from 2 years to 30 years but bonds with maturities of 50 or 100 years also exist. Bonds issued with maturities of less than 10 years are usually called notes. A very small number of bond issues have no stated maturity and these are referred to as perpetuities or consols. 2 Chapter 10 Straight Bonds The most common type of bond is the so-called straight bond. By definition a straight bond is an IOU that obligates the issuer to pay to the bondholder a fixed sum of money at the bond s maturity along with constant periodic interest payments during the life of the bond. The fixed sum paid at maturity is referred to as bond principal par value stated value or face value. The periodic .