explain the four important relationships on bond valuation

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  • First relationship
    The price of a bond is inversely related to its yield-to-maturiy (YTM). Since YTM depends positively on the market interest rate, we can infer that as market interest rate increases (decreases), bond value decreases (increases). The change in value caused by changing interest rates is called interest rate risk.
  • Second relationship
    1. If the bondholder’s YTM equals the coupon interest rate, the bond will sell at par, or maturity value.
    2. If the YTM exceeds the bond’s coupon rate, the bond will sell below par value or at a “discount.” This is called a discount bond.
    3. If the YTM is less than the bond’s coupon rate, the bond will sell above par value or at a “premium.” This is called a premium bond.
  • Third relationship
    Longer-term bonds are exposed to greater interest rate risk than shorter-term bonds.
  • Fourth relationship
    Lower-coupon bonds are exposed to greater interest rate risk than higher-coupon bonds.