Question

Q1: As interest rate rises, bond price decrease. How to understand the relationship of bond price and interest rate? Could you show us a real example?

Q3: What’s yield to maturity (YTM)? capital gain yield? current yield? How about their relationships?

Q4: What’s Yield to Call (YTC)? What’s the difference between YTC and YTM?

Answer 1

Answer - 1

"As interest rate rises, bond price decrease."

Interest rate on bond is the income to be received by the investor who invests his money in the bond. As and when the income to be received increases the expectation of the investor from the capital gains from the bond decreases because the investor is already receiving a higher rate of interest income from the bond which eventually recover his investment cost in bonds faster in a short period of time.

For example -

If there is a bond with face value of $100 with interest rate of 10% upto perpetuity,

then the present value of the bond will be = $100 / 10% = $1000

On the other hand, If there is a bond with face value of $100 with interest rate of 15% upto perpetuity,

then the present value of the bond will be = $100 / 15% = $666.67

Hence, from the above example we can conclude that as interest rate rises, bond price decrease.

Answer - 3

Yield to maturity (YTM) - YTM is the total average return (in percentage) to investor from investment in security for the period starting from the purchase of the security till the security matures. YTM is represented in annual rate which can be calculated on the basis of years remaining to maturity. It is the yield from the view point of investor and not from the point of security issuer. It can be said that a YTM is the internal rate of return of an investment in a security to the investor.

Capital gain yield - Capital gain yield is the capital appreciation (in percentage) from a security which is the difference between the maturity value of a security and the purchase cost of a security. Capital gain yield does not include the interest income accrue / received by the investor, it measures only the change in the value of a security in terms of annual percentage rate.

Current yield - Current yield is the annual return (in percentage) from a security to the investor on its current investments in the security. It is the actual return expected / earned by the investor in a year of holding investment on the current value ot such investment. Current yield does not include the capital gain appreciation in a security in that particular year.

Answer - 5

Yield to Call (YTC) - YTC is the total average return (in percentage) to investor from investment in security for the period starting from the purchase of the security till the security is called upon by the issuer which can be the date before the maturity date of the security. Yield to call applies to callable bonds which can be redeemed by the issuer before the date of maturity of the bond.

Difference between YTC and YTM -

1. YTM is the total return on a security from the purchase to its expiration. On the other hand YTC is the total return on a callable bond from the purchase to the date of call.

2. YTM can be on any security, but YTC can be only on callable bonds which allow the issuer to redeem the bond on a date before the maturity date of the bond.