Bond Concepts

Question 1

What is Yield to Maturity (YTM)?

Answer 1

The internal rate of return (IRR) on a bond — the discount rate that equates the present value of all future coupon payments and redemption value to the bond’s current market price.

Question 2

What happens to a bond’s price when market interest rates rise?

Answer 2

The bond’s price falls, because its fixed coupon payments become less attractive compared to new bonds with higher yields.

Question 3

What happens to a bond’s price when market interest rates fall?

Answer 3

The bond’s price rises, because its coupon payments are higher than what new investors can earn on new issues.

Question 4

How does YTM compare to the coupon rate at different price levels?

Answer 4

At par: Coupon rate = YTM
At discount: Coupon rate < YTM
At premium: Coupon rate > YTM

Question 5

What is the approximate formula for YTM?

Answer 5

YTM ≈ C + (FV - P) / n (FV + P) / 2

where C = annual coupon, FV = par (usually 100 or 1,000), P = price, n = years to maturity.

Question 6

What is Duration and why does it matter?

Answer 6

Duration measures a bond’s price sensitivity to interest rate changes — the approximate % price change for a 1% change in yield.
Longer duration = more rate-sensitive.
Shorter duration = less rate-sensitive.

Question 7

What’s the relationship between coupon rate, duration, and rate risk?

Answer 7

Lower coupons & longer maturities = higher duration (more risk)
Higher coupons & shorter maturities = lower duration (less risk)

Question 8

Why is YTM a better measure than current yield?

Answer 8

Because YTM includes both interest income and capital gain/loss from buying below or above par, while current yield only considers coupon ÷ price.