Question

Write out the 3 rules about the relationship between coupon rate and yield, and the effect on bond price, AND write what happens to bond prices when yields go up and what happens when yields go down

Answer 1

Three rules are for the relationship between coupon rate and yield:

1) If the coupon rate is more than yield rate i.e the market rate than the bonds are issued at premium to offset the difference between the two rates, so that investors get the same return as is in the market. The bond issue price is higher than the par value.

2) If the coupon rate is less than yield rate i.e the market rate than the bonds are issued at discount to offset the difference between the two rates, so that investors get the same return as is in the market, as the investors wont be interested in getting less returns than in market. The bond issue price is less than the par value.

3) When the coupon rate is same as yield rate than the bonds are issued at par, hence investor will get same return in both case. The bond issue price is same as the par value.

When the yield go up bond prices decreases as the market rate is higher than coupon rate so there will be discount.

When the yield go down bond price increases as the market rate is lower than coupon rate so there will be premium on bonds