Question

1. What is the difference between coupon rates and yield to maturity, and how do these differences impact bond prices?

2. Why are long-term bond prices more volatile than short-term bond prices?

3. How might the yield to maturity change for an organization in the event of a credit upgrade or downgrade by rating agencies?

4. Fixed income securities are generally considered less volatile than equity securities. Why do high-yield bonds more closely resemble equity volatility?

Answer 1

1. The Yield to Maturity is the estimated rate of return for bond assuming that the investor will hold the bond till its maturity, It is the sum of all coupon payments to be received till its maturity, A bond YTM to maturity increases depennding upon its market price. Coupon rate is the annual income an investor will get while holding the bond.

2. The Long term bond prices are more volatile since it carries more risk due to inflation changing the rate of cahflows which can change the value of bond which is dependent upon the cashflows. since short term bond has to face lower inflation changes since it is less volatile.

3. In simple words higher the credit rating lower will be the interest rate the borrower has to pay. Since the coupon rate is low then the YTM will also be low and if rating is downgraded then the coupon rate will increase and hence YTM will also increase.

4. SInce the high yield bonds have lower credit rating which implies they have high volatility hence they resemble closely to equity.