Analyze Bond Pricing Factors - Series 65

Compute the credit spread if $y_{\text{bond}}=6\%$ and $y_{\text{benchmark}}=4\%$ .

$2\%$ (or $200$ basis points). Subtracting the benchmark yield from the bond yield gives $6\% - 4\% = 2\%$ , equivalent to 200 basis points.
Identify the bond price status when coupon rate equals yield to maturity.

Trades at par (approximately $100$ ). When coupon rate matches yield to maturity, the present value of cash flows equals par, resulting in trading at face value.
State the duration-based approximation for percent price change.

$\frac{\Delta P}{P} \approx -D \times \Delta y$ . This approximation estimates the percentage change in bond price as the negative product of duration and the change in yield.
What happens to a bond's price when its credit spread narrows (benchmark yield unchanged)?

Price increases. Narrowing spreads lower the bond's yield, enhancing its attractiveness and elevating its market price.
Which bond has greater price volatility: longer maturity or shorter maturity (all else equal)?

Longer maturity has greater price volatility. Bonds with extended maturities have cash flows weighted further in the future, amplifying their sensitivity to interest rate fluctuations.
Using duration, estimate $\frac{\Delta P}{P}$ if $D=8$ and $\Delta y=-0.005$ .

$\frac{\Delta P}{P} \approx +0.04$ (about $+4\%$ ). Applying $-D \times \Delta y$ gives $-8 \times (-0.005) = 0.04$ , showing an approximate 4% price increase for a 0.5% yield decrease.
What happens to a bond's price when its credit spread widens (benchmark yield unchanged)?

Price decreases. A widening spread increases the bond's yield, making it less attractive and thus reducing its market price.
State the formula for credit spread relative to a benchmark yield.

$\text{Credit spread} = y_{\text{bond}} - y_{\text{benchmark}}$ . Credit spread is calculated as the difference between the bond's yield and that of a comparable benchmark, capturing risk premium.
What is credit spread in bond pricing?

Yield above a benchmark to compensate for credit risk. Credit spread reflects the additional yield demanded by investors to offset the higher default risk compared to a risk-free benchmark.
Which bond typically has the highest duration, all else equal: zero-coupon or coupon-paying?

Zero-coupon bond. Zero-coupon bonds lack interim payments, weighting all cash flow at maturity and thus exhibiting the longest duration.
Identify the bond price status when coupon rate is less than yield to maturity.

Trades at a discount (below par). A lower coupon compared to yield decreases the present value below par, leading to trading at a discount.
Which bond is more price sensitive to yield changes: $D=7$ or $D=3$ (all else equal)?

$D=7$ is more price sensitive. Higher duration indicates greater sensitivity to yield changes, as it measures amplified price volatility per unit of yield shift.
What does a bond's maturity measure?

Time remaining until principal is repaid at par. Maturity indicates the period until the bond issuer returns the face value, influencing the bond's sensitivity to interest rate changes.
How does duration change as time to maturity increases (all else equal)?

Duration generally increases as maturity increases. Extended maturities delay cash flows, increasing the weighted average time and thereby elevating duration.
Using duration, estimate $\frac{\Delta P}{P}$ if $D=5$ and $\Delta y=+0.01$ .

$\frac{\Delta P}{P} \approx -0.05$ (about $-5\%$ ). The formula $-D \times \Delta y$ yields $-5 \times 0.01 = -0.05$ , indicating an approximate 5% price decline for a 1% yield increase.
What is reinvestment risk for a bondholder?

Risk that coupons are reinvested at lower rates. Falling interest rates force bondholders to reinvest periodic coupon payments at lower yields, reducing overall returns.
Which bond has greater interest rate risk: a $30$ -year $3\%$ coupon or a $5$ -year $6\%$ coupon?

The $30$ -year $3\%$ coupon bond. Longer maturity and lower coupon combine to increase duration, heightening exposure to interest rate fluctuations.
Which bond has greater price sensitivity: lower coupon or higher coupon (all else equal)?

Lower coupon has greater price sensitivity. Bonds with smaller coupons have a greater proportion of value in the distant principal repayment, increasing sensitivity to yield changes.
What is the relationship between bond prices and market yields (interest rates)?

Bond prices move inversely to market yields. When market yields rise, existing bonds become less attractive, causing their prices to fall to offer competitive yields, and the opposite occurs when yields decline.
What is interest rate risk in bond investing?

Risk that bond price changes when market yields change. Bond prices fluctuate inversely with changes in prevailing interest rates, exposing investors to potential capital losses or gains.
How does duration change as coupon rate increases (all else equal)?

Duration generally decreases as coupon rate increases. Higher coupons provide earlier cash flows, reducing the weighted average time to receipt and lowering duration.
Identify the bond price status when coupon rate is greater than yield to maturity.

Trades at a premium (above par). A higher coupon relative to yield increases the present value of cash flows above par, commanding a premium price.
What is a bond's coupon rate?

Annual interest stated as a percent of par value. The coupon rate determines the fixed periodic interest payments relative to the bond's face value, affecting its pricing and yield.
What is the definition of duration as used in bond analysis?

A measure of a bond's price sensitivity to yield changes. Duration quantifies the weighted average time to receive cash flows, approximating the percentage price change for a given yield shift.
Which issuer typically has the smallest credit spread: U.S. Treasury or high-yield corporate?

U.S. Treasury. U.S. Treasuries are considered risk-free, requiring no additional yield premium for credit risk unlike high-yield corporates.

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