BOND

THEOREM
THEOREM 1: The price of a bond is inversely
related to the yield to maturity (market interest
rate).

• The market interest rate has an inverse effect

on bond prizes. When the market interest goes
up market prizes of bond goes down and vice
versa.
• Let us take a bond of value Rs. 100 with coupon
payment of 8% maturing exactly in 10 years.

• When market interest rate is 9%, its prize would

be
Price = coupon rate * PVIFA + Face value * PVIF
Price = 8 * 6.4177 + 100 * 0.4224
= Rs. 93.58

PVIFA=
[1/(1+0.09)1+ 1/(1+0.09)2 +1/(1+0.09)3 +………..+
1/(1+0.09)10 = 6.4177

PVIF= 1/(1+0.09)10 = 0.4224

• When the market interest rate goes up by
say 1% to 10%, the price of the bond would
be:

• Price = Rs.8 x 6.1446 + Rs.100 x 0.3855 = =

Rs.87.71

• We notice that the price of the bond has fallen

to 87.71 when interest rate has risen to 10%
from 9%.
• When the market interest rate goes down
from 9% to 8% the price of the bond would
be:

Rs.8 x 6.7101 + Rs.100 x 0.4632

= Rs.100
• We notice that the price has gone upto Rs.100
from Rs.93.58. Thus, we conclude that bond
prices and yield are inversely related.

• An interesting observation that can be made

from the above discussion is that the price of
the bond is Rs.100 (par) when the market rate
and the coupon of the bond (8%) are the same.
THEOREM 2: When the interest rate goes down
by a certain percentage is greater than when the
interest rate goes up by the same percentage.

• In other words, given the same level of say 1 %

change in interest rate, the price appreciation
on account of interest rate going down by 1 %
is greater than the price depreciation on
account of interest rate going down by 1%.
For example:

• Take 9% as a base
When interest fell from 9% to 8%:
Rs. 100 - Rs. 93.58 = Rs. 6.42
6.42/93.58 * 100 = 6.86%
When interest rate went up from 9% to 10%:
93.58 – 87.71 = Rs. 5.87
5.87/93.58 * 100 = 6.27%
•From 9% to 8% the percentage change
would be 6.86% whereas the depreciation
was 6.277% when the interest rate went
up from 9% to 10%.
Theorem 3: Longer the term to maturity of a bond,
higher will be its price sensitivity.

• If we have two bonds of same coupon say 8% one

maturing in 10 years and the other maturing in 7 years,
the 10 years bond will experience more price
sensitivity than the 7 years bond.
• In the example we worked out (for theorem 1)
we have seen the price depreciation of the bond
maturing in 10 years with a coupon of 8%
when the interest rate went up from 9% to 10%
is Rs.5.8748 and the change in price = 6.277%.
• When maturity period is 10 years and market
interest rate is 9%, its prize would be
Price = coupon rate * PVIFA + Face value * PVIF
Price = 8 * 6.4177 + Rs. 100 * 0.4224 = Rs. 93.58
• When the market interest rate goes up by say 1%
to 10%, the price of the bond would be:
Price = Rs.8 x 6.1446 + Rs.100 x 0.3855 = Rs.87.71
Change in percentage:
93.58 – 87.71 = 5.87
5.87/93.58 * 100 = 6.27%
• If we calculate the price of the 7 years bond at 9%
and 10% we find the depreciation is Rs 4.697, as
shown below:
• Price at 9% = 8 x 5.0330 + 100 x 0.5470 = Rs.94.964
• Price at 10% = 8 x 4.8684+ 100 x 0.5132 = Rs.90.267
• The percentage change in price = [(94.964 –
90.267)/94.964] x 100 = 4.946%
• The depreciation in the price of the 10 years
bond is obviously more than the depreciation in
the 7 years.
Theorem 4: Between two bonds of same maturity but different
coupons, the bond with the lower coupon will experience more
price sensitivity than the one with higher coupon.

• Let us say there are two bonds of ten years maturity with
coupons 8% and 6% respectively.
• When the market interest rate is 9%, the price of the bond
with coupon 8% is 93.5816.
• Price = 8 * 6.4177 + Rs. 100 * 0.4224 = Rs. 93.58
• And the price of the bond with coupon 6% is 80.7462.
• Price = 6 * 6.4177 + Rs. 100 * 0.4224 = Rs. 80.74
• If the market interest rate changes to 10% from 9% the
prices of the bonds are 87.71.
•PVIFA= {1/(1+0.06)1+
1/(1+0.06)2+1/(1+0.06)3+………….+1/(1+0.0
6)10
• = 6.4177
• PVIF= 0.4224
• P0= I*PVIFA+PA*PVIF
• = 6*6.4177+ 100* 0.4224
P0= Rs. 80.74
• The percentage changes in the price of these bonds
(6.277% and 6.60% respectively) clearly indicate the
higher price sensitivity of the bond with the lower
coupon (i.e. 6%).

• 8% COUPON = 6.277%
• 6% COUPON = 6.60%
Theorem 5:

• Between two bonds of same coupon and same

maturity but differing coupon payment
intervals, the bond with higher frequency of
coupon payment is less sensitive to price
changes when market interest rate changes.
• Let there be two bonds of 8% coupon and of 10 years
maturity. Bond A pays coupon semiannually and Bond
B pays annual coupons. We can observe that the bond
A which pays semiannual coupons is less price
sensitive to interest rate changes.