The bond market

by | Mar 6, 2023 | economics

 

 

 

 

 

 

Why is the bond market so sensitive to interest rates? What is the mathematics behind this relationship? Do a Google search to find a corporate bond issue where the company has either defaulted on the payments or called back the bonds.

Sample Solution

The bond market is especially sensitive to interest rates because the price of a bond and its yield (or rate of return) are inversely related. This means that when interest rates go up, the value of bonds goes down and vice versa. The mathematics behind this relationship can be seen by looking at the formula for calculating a bond’s yields: Yield = Coupon Rate/(1 + RV/N), where RV is the current market value of the bond, N is the number of payments left on the bond, and Coupon Rate is set by the issuer. As interest rates rise or fall, so too does RV since it reflects changes in prevailing interest rates – as interest rates increase, RV decreases resulting in lower yields for investors.

Sample Solution

The bond market is especially sensitive to interest rates because the price of a bond and its yield (or rate of return) are inversely related. This means that when interest rates go up, the value of bonds goes down and vice versa. The mathematics behind this relationship can be seen by looking at the formula for calculating a bond’s yields: Yield = Coupon Rate/(1 + RV/N), where RV is the current market value of the bond, N is the number of payments left on the bond, and Coupon Rate is set by the issuer. As interest rates rise or fall, so too does RV since it reflects changes in prevailing interest rates – as interest rates increase, RV decreases resulting in lower yields for investors.

Despite their sensitivity to fluctuations in interest rates, corporate bonds remain an attractive option for many businesses due to their relatively low cost compared to other forms of borrowing. Unfortunately there have been instances where companies have defaulted on their payments or called back their bonds before maturity dates were reached due to financial difficulties or other reasons – one such example is Toys R Us which filed for bankruptcy in 2018 prior to any repayment being made on its debt securities (bonds).

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