Question

2. List the various determinants of bond yields (required returns) and explain how each of these determinants will affect the bond interest rate.
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Answer 1

2. The various factors affecting the bond yield :

• The credit ratings of the issuer : if the credit ratings of the issuer is high , then there is a less chance of the bond defaulting and hence the required return of the investors is low and vice versa. The higher the ratings , lower is the interest rates on the bond.
• Time to maturity : the higher the time to maturity of the bond, the higher will be the required return of the bond. The greater the time to maturity , higher the interest rate of the bond. So, the issuers pay higher interest rates with the higher maturity bonds , as the risks involved is high.
• The economic growth : the higher the growth rate of the economy. lower would be the yield on the bond required by the investors and the interest rates on the bonds would be high.
• Higher inflation rate : the higher the inflation rate, all the returns from the bonds will be washed away hence the yield required by the investors will be high. The interest rate on the bond would be high.