Question-61: What is the relation between bond price and interest rates?

Answer: Bond price moves opposite direction of the interest rates. If interest rates fall the bond price would increases and at the same time if interest rates increase then bond price would reduce.

Question-62: If investor is holding the bond till maturity, so does he have any interest rate risk?

Answer: If investor is holding a bond till maturity, it means there is no impact on his investment because of interest rates change. And no interest rate risk he has. But he want to sell the bond before maturity and interest rates increases then bond price would reduce and he would make a capital loss.

Question-63: So YTM gives the real picture for an investor?

Answer: Usually not, because investor usually don’t want to hold the bond till maturity or getting the same return as YTM rate on the future coupon is also difficult.

Question-64: So, investor should choose the bond which has higher YTM?

Answer: If investor choose a bond with high YTM, he has to re-invest the coupon at the same rate as YTM (very difficult to get). And if he wants to sell the bond in between then it is possible that bond price may reduced because of high interest rates in the market. YTM is useful or not depend on the investor’s expectations. And what is the horizon he is having for his investment.

Question-65: What do you mean by yield-to-call?

Answer: As name suggests it is applicable to the bond which are callable by issuer. And as an investor you want to calculate the yield on the bond if is hold till the issuer call the bond. Hence, you can say it is an interest rate that will make the present value of each future cash-flows equal to the current price of the bond, if bond is hold till call date. In case of yield to maturity bond is hold till maturity.

To understand the cashflows on the callable bond, let’s take an example. If you have a bond with 7% annual coupon. Maturity of 20 years. And this bond can be called 5 years after issue with the bond price as $1100. So what are the future cashflows

• Coupon payment for 5 years = $35*10=$350 (We are assuming coupon payment twice a year)
• $1100 when the bond would be called.

And we need to calculate the Yield to call which makes bond’s future cashflow equal to present value pf the bond. Assume after calculation it gives you 14%, so your yield to call is 14%, again it is assumed that you are re-investing every cashflow (coupon, you receiving every six month) which give you the return as 14% as well.