Question-41: What would happen when you buy a bond either on premium or discount and required yield does not changes. And it is reaching towards maturity?

Answer: If bond purchased on

• Discount: Then its price would increase as it reaches towards the maturity and required yield does not changes.
• Premium: In this case price would decrease as this moves towards the maturity.
• Par value: If bond is purchased on par value and required yield and coupon rate does not change then price of the bond also remain equal to the par value as move towards the maturity.

Question-42: What all are the common cases for which bond price changes?

Answer: Following are the common reason, because of which price of the bond would changes

• Change of the interest rates: Interest rate and bond price moves in reverse direction.
• Maturity: If bond moves towards the maturity. Its price changes, up or down depend whether it was purchased on the par, premium or discount.
• Treasury spread change: If bonds required yield does not change also treasury rates also does not change. But the spread between treasury and non-treasury bond changes. It can be either widen or narrowed then accordingly prices of the bond would change.
• Credit quality of the issuer: If no other parameters changes but the credit quality of the issuer decreases then bond price would also decrease. And similarly, if credit quality increases of the issuer then bond price would also increase accordingly.
• Embedded options: The price of the bond would change as factors that affect the underline embedded option changes.

Question-43: How does investor make money on zero coupon bonds?

Answer: Investor make money by buying the bond at lower price then its par value. And calculation of price is same as with the bond which has coupon. But it has only one future cashflow that is par value at maturity.

Question-44: Can you give an example of calculating a price of a bond with zero coupon?

Answer: Lets have the below formula for calculating the bond price. But we have 0 coupon, so C=0

C*[(1-{1/(1+i)^n})/i] + M/(1+i)^n

Example a zero coupon bond having par value is $1000 and required yield is 10% with maturity 10 years. We can calculate bond price as below

1000/(1+0.05)^20

Assuming 0% rate of coupon every six month. Hence, total period would be 10*2=20. Which results in $376.89

Hence, you should not give more than $376.89 for the bond with par value $1000, with maturity 10 years. If you want to have yield as 10% annual.

Question-45: Does it affect if you buy the bond between coupon dates, means bond settlement date is not as coupon date?

Answer: Yes, it would affect. We need to know following things to derive the actual price of the bond.

• Days for next coupon: Number of days remaining for next coupon date.
• Present value: Determine the future cashflow’s present values. Because coupon should have already be received for the day’s passed from the coupon dates.
• Accrued interest: Buyer has to pay the interest amount for the days bond held by the seller. Since he has not received the interest for those days.