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 Explain the concept of Coupon bond yields and its pricing behavior

2 Discuss the ‘Term Structure of Interest Rates’ and how it related to the Yield Curve

3 What are the different shapes of the yield curve

Answer 1

1. Concept of coupon bond yield means that there is a coupon associated with the bond which is to be paid upon the face value of the bond and this coupon rate is always uniform in nature. The coupon rate will decide the attractiveness of the bond in different economic scenario.

Lower coupon yield than prevelent interest rate in the market will be considered unattractive, and higher coupon yield which is higher than prevalent market rate of interest will be considered more attractive.

2. Term structure of interest rate define interest rate in various durations and link them to the bond yields, so it can be said that is the relationship between interest rates and the bond yield .when the term structure is marked on curve, it will mean that it will result into yield curve.

3.Various shapes of yield curve-

A. Normal curve reflect that bond yields on the short-term bonds are lower than the bond yields on the long term bonds and it will mean that there is a normal economy.

inverted yield curve is a structure of which determines that when the short term bond yields are higher than long term bond yield, so it will mean that there is a recessionary like scenario in the overall economy because people are expecting that in the long run, the bond yields are going to be lower.

flattening of yield curve is another scenario, in which short term bond yields and long term bond yields are similar in nature, it is reflecting situations getting to normal from a recessionary situation.