Bond Pricing, Duration, and Yield
Bond pricing refers to determining the present value of a bond's future cash flows, including interest payments and principal repayment, discounted at an appropriate rate. Duration measures a bond's sensitivity to changes in interest rates, indicating how much its price will fluctuate with rate movements. Yield represents the return an investor can expect from holding the bond, commonly expressed as yield to maturity, which considers both interest payments and any capital gain or loss if held to maturity.
Bond Pricing, Duration, and Yield
Bond pricing refers to determining the present value of a bond's future cash flows, including interest payments and principal repayment, discounted at an appropriate rate. Duration measures a bond's sensitivity to changes in interest rates, indicating how much its price will fluctuate with rate movements. Yield represents the return an investor can expect from holding the bond, commonly expressed as yield to maturity, which considers both interest payments and any capital gain or loss if held to maturity.
💡 Key Takeaways
- Bond price is the present value of all future cash flows (coupon payments and principal) discounted at the appropriate yield.
- Bond prices move inversely to yields: when yields rise, prices fall, and when yields fall, prices rise.
- Duration measures a bond's price sensitivity to interest rate changes and approximates the percentage price change for small rate moves.
- Understand different yield concepts (such as yield to maturity and current yield) and how coupons, price, and time to maturity affect them.
- Convexity describes the curvature in the price–yield relationship and helps adjust duration-based estimates for larger rate changes.
❓ Frequently Asked Questions
What is bond pricing?
Bond pricing is the process of determining the present value of a bond's future cash flows (coupons and principal) by discounting them at an appropriate market rate.
How are a bond's cash flows used in pricing?
Each coupon payment and the principal repaid at maturity are discounted back to today and summed to get the price.
What does yield mean in bond pricing?
Yield is the rate that makes the present value of a bond's future cash flows equal to its price; yield to maturity is the common measure when you hold to maturity.
What is duration, and why does it matter for price changes?
Duration measures how sensitive a bond's price is to interest-rate moves; higher duration means larger price changes for a given rate change, approximately price change ≈ -Duration × ΔYield × Price.