InvestorQ : Is the yield to maturity or the YTM related to the price of the bond and if so, then how?
Aashna Tripathi made post

Is the yield to maturity or the YTM related to the price of the bond and if so, then how?

Answer
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Tisha Malhotra answered.
1 year ago


Entire bond analysis is based on the inverse relationship between yields and bond prices. Yields and Bond Prices are inversely related. So a rise in price will decrease the yield and a fall in the bond price will increase the yield.

There will be an immediate and mostly predictable effect on the prices of bonds with every change in the level of interest rates. (The predictability here however refers to the direction of the price change rather than the quantum of the change)

When the interest rates in the market rise, the prices of outstanding bonds will fall to equate the yield of older bonds into line with higher-interest new issues. This will happen as there will be very few takers for the lower coupon bonds resulting in a fall in their prices. The prices would fall to an extent where the same yield is obtained on the older bonds as is available for the newer bonds.

When the prevailing interest rates in the market fall, there is an opposite effect. The prices of outstanding bonds will rise, until the yield of older bonds is low enough to match the lower interest rate on the new bond issues. Essentially, the price acts as the balancing factor which adjusts the attractiveness of the bond by tweaking its market price in response to changes in the yield.

These fluctuations ensure that the value of a bond will never be the same throughout the life of the bond and is likely to be higher or lower than its original face value depending on the market interest rate, the time to maturity (or call as the case may be) and the coupon rate on the bond.