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Relationship between Bond value, Market Interest rates and Coupon rate-converted
Computer Soft (CS302)
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NBONDVA1UE,HARKETINTERESTRATEANDC0UP0WeAW
gggmple 5 4 shows that value of a bond depends upon many factors such ao coupon rate,
g,g,3ret ra te of return, maturity period an edemption
repayment. In this section, the
;„j;g,ggt;¿pn between these factors and the bond valuation haa been discussed. As the interest
,p¿g varies, the bond value also changes. The variability in interest rate is known as the
‹ qje ,ggJ rvst e rJsA which is different from the business risk and fmaocial risk. The
ioterest
rate risk map be defined as the probability that bond prices will fall because of increase in
te k may be found in ebon
The degree of interest rate risk associated with a specific The degree of interest rote
bond is basically a function of the time to maturity, i., the rish as
.number of yearn tik maturity. This itg,_,g_ee risk is hi • Recific bonds is basicall y
ease of b nd of 1 er turit a co to e bond a function of the time to
tv. The reaaon for this obvious. The bond with a_ maturity
l‹vn er atuxi ia more ex osed to variations in interest rate.
This argument alao explains as to wñy the short-term b n s have lower rate of interest than
the long-texm bondo. Thus, if a firm has issued bonds
of dioerent maturity periods, then even
if‘ thp face value
and coupon rates are same, the bonds of different maturity period will
have
120
$pyzJg valuea. Bond
val;;gg$
the different degrees
sed belt
ba
the requir ed
rate of
jyyya rata ar
eqtjBl, the bOild value
ond
known Bs the
ia
pppd
6.
al
paev er, if the
the
equBto the par
jjom the coupon te, the value ie less
differ er1t
urn i.« more than
required rate of ret
§pppose, 8K bond| ,•••›)•= •••
pm »f 2 a year» !+^
Va t3e
• t 4 l Pgp
goad Y•*•^
Rs. 1,B
1,
T’h 'se value
mv.
present the rate of return chanyeJ nZtZf )t ultimately e f fect8 the that required rate of interest and bond valuea aubatantiated aa folloW$ market rates o/ interest, boRd VO Ju es. Investors must Itl0ve inversely. This can
####### the
At ii., higher required ved the investor the the rate will also decrease reooJ$ing in higher present ret urn), the is lower. So, the bon of aluea . So, the bondess
the lnuerae relat•’o• •* iR bettoeen the interest rates and the bond upJpptiort provided t decreasing rate. and time to maturity also affects « to Mattzz’tty• IN thezegulzsd rate of retttm ts dif'Eerent from same Bond Value (Rs.) Reeguired Rate of RetUr = 8o Face Value Required Rate of Return = 10%”. Required Ra“te"o”f R"etuurn - 2% 10 87 54 Time to Maturity (Years) of shorter-term bonds. In other worda, the price volatility is a function This can be further substantiated aa follows : rate of return are equal, the bond will sell at par gain is neoeaeary to provide fair compensation to the than the required rate ot’ return, the coupon raturn the d the bond valuation provides the basis aB tO why the change. However, the exact amount of depend yield decline› upon the time to maturity and the bontl value-yiald relationship la not straight, eather it is convex. As tocreaaea at anincreasing rate and aa the yield increases, the value ¿ y1gure 5. OJ : Betadonship between Required Rate of Return, Time to Matuity and Bond Value. S ahows that the e8ect of change in required rate of return on the bond value on the time to maturity of the bond. The prices of longer-term bonds tend to change
Relationship between Bond value, Market Interest rates and Coupon rate-converted
Course: Computer Soft (CS302)
University: Musalir College of Engineering, Chirayinkeezhu
