Question

In chapter 6, Bond Valuations techniques are introduced A bond is a debt security, like ‘IOU.’ The bond issuers borrow from the Bond Investors. The issuers agree to repay the principal amount of the loan on the maturity date. Thus, a bond represents loans from the holder to the issuer. In this assignment, you are to discuss the following with numerical examples:

1. What are the determinants of the shape of the yield curve
2. What does it mean when a bond sells at a premium or when it sells at a discount?
3. Discuss the relation between a corporate bond’s expected return and the yield to maturity; define default risk and explain how these rates incorporate default risk.
4. Assess the creditworthiness of a corporate bond using its bond rating; define default risk.

Answer 1

A yield curve is a curve on which various bond yields of different maturity are plotted so that an investor gets a fair idea, about the rate of bond yields which are being offered in the short-term & offered in the long term.

There are various determinants of the shape of the yield curve-

A. Interest rate-interest rate is always the biggest determinant of the the shape of the yield curve because the bond yield are always reacting to the change of the interest rate by the monetary policy of the Federal Reserve, and it is often used as the primary tool for the change in the bond yields.

B. Inflation rate- These are also impacting the shape of the yield curve because the monetary policy are prepared after taking intoiconsideration the inflation rate which is currently prevalent in the economy

C. it is also determined by the economic cycle because in a recessionary cycle, there would be an inverted yield curve and in the normal cycle, there would be a normal curve

D. it is also driven by the sentiment of various investors due to various market events, and it can always be unpredictable in nature.