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A 15 year bond is issued with a face value of 5000, paying interest of 300...

A 15 year bond is issued with a face value of 5000, paying interest of 300 a year. If yields to maturity increase shortly after t bond is issued, what happens to the bond . Coupon rate ? .. price ?

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Expert Solution

ANSWER

IF YIELD TO MATURITY INCREASES SHORTLY, THEN :

ITS AFFECT ON COUPON RATE :

  • The Increase or Decrease of Yield to Maturity does not affect the Coupon rate because the Coupon Rate of a Bond is FIXED throughout the tenure of the Bond.
  • Coupon Rate is Fixed at the time of Issue of bond only and does not vary at with other factors such as change in yields and market interest rates etc.
  • Hence NO CHANGE IN COUPON RATE.

ITS AFFECT ON BOND PRICE :

  • When Yield to Maturity increases, it means that now the Investor's Expectation have increased and now they demand more return from such Bonds.
  • BUT Since the Return from the Bond in terms of Coupon Payment remains fixed, the Bond holders starts exiting from such bond and the Bond Price starts falling.
  • Also in other words, since Yield to Maturity is the Discount Rate with which we discount out Cash Inflows from the Bond in order to compute "bond price" , the Higher will be our Discount Rate Lower will come our Bond Price.
  • Hence we can conclude that BOND PRICE WILL FALL.

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