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Wize University Introduction to Finance Textbook > Bond Valuation

Interest Rate Risk

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Bond Price Sensitivity

Market interest rates have an inverse relationship with bond prices, that is because if market interest rates (YTM) rise, the present value of existing bonds will decrease. However not all bonds move equally, some bonds are very sensitive to changes in interest rates, while others are less sensitive. Sensitive bonds will decrease or increase in price by more than less sensitive bonds.

What does the Price-Yield Curve tell us?

  • Bonds are more sensitive to change in interest rates when yields are lower.
  • Bonds are more sensitive when rates/yields decrease then when they increase.

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Characteristics that increase bond sensitivity

  • Long maturities
  • Low coupons
  • Low YTM
  • Higher frequency of payments

For Example:

Consider the following two bonds, both have a face value of $1,000
Bond A: 10-year maturity, 5% coupons paid annually
Bond B: 30-year maturity, 5% coupons paid annually

Bond A: When YTM = 6%, Bond A is priced at $926.40; if YTM increases to 7% the price decreases by 7.21% to $859.53
Bond B: When YTM = 6%, Bond B is priced at $862.35; if YTM increases to 7% the price decreases by 12.82% to $751.82

Example: Bond Price Sensitivity

ABC Inc. has bonds outstanding with a $1,000 face value. The coupon rate on these bonds is 7% and coupons are paid annually. The bonds mature in 10 years. What is the percentage change in the price of the bond if the yield to maturity increases from 7% to 8%?

Practice: Bond Price Sensitivity

ABC Inc. has bonds outstanding with a $1,000 face value. The coupon rate on these bonds is 6% and coupons are paid semi-annually. The bonds mature in 8 years. The bond's are currently priced at par. What will be the percentage change in the price of the bond if the yield to maturity decreases by 50 basis points?

The percentage change in price is
%

Round your final answer to 2 decimal places.


Extra Practice
Which of the following bonds would experience the largest decrease in price if interest rates rise by 1%?
Which of the following bonds would experience the smallest decrease in price if interest rates rise by 1%?
Which of the following statements is correct?
WIZE Corp has 8.75 percent coupon bonds yielding of 9.25 percent. The bonds have twenty years to mature and make semi-annual interest payments. What is the percentage change in price for a 10 percent increase in the yield to maturity?
Which of the following bonds is least sensitive to changes in interest rates?
Which of the following bonds is most sensitive to changes in interest rates?
Which of the following factors does not determine a bond's interest rate sensitivity?
WIZE Corp has 8.75 percent coupon bonds yielding of 9.25 percent. The bonds have twelve years to mature and make annual interest payments. What is the percentage change in price for a 150 basis point decrease in the yield?