1.Identify at least four factors that affect a bond’s yield and explain the effe
ID: 2741484 • Letter: 1
Question
1.Identify at least four factors that affect a bond’s yield and explain the effect each factor has on the yield.
2.value of a stock (i.e. stock price) is the present value of ALL its future dividend. In real world, an investor will normally hold the stock for a limited time (for example, 3 years). Therefore, this investor receives only dividends during this period (e.g. dividends during the 3-year holding period). Why dividends afterwards (e.g. why dividends after year 3) are relevant to this investor?
3. Why price of a stock with constant growing stock grows at the same rate as the dividends?
Explanation / Answer
1. Factors that effect Bond’s Yield
(a) Price: If price is below the face value, the bond is at a discount. A bond selling for more than face value is at a premium. You pay more for the bond, so your effective interest rate goes down. The effective interest rate is the yield.
(b) Interest rates: When interest rates climb, existing bonds become less attractive to investors. Demand for the bonds declines and the price tends to drop until yields increase enough to attract investors. When interest rates go down, existing bond yields become more attractive. Yields fall until they are comparable to the new market interest rates.
(c ) Credit Risk: Bonds investors accept a risk that a bond issuer might not be able to pay off the borrowed money when the bond matures. If rating of bonds goes down, demand for the bonds tnds to fall. Price drops and yield rise. Eventually yield rise enough to attract investors willing to accept greater risk in exchange for the higher yields.
(d) Maturity: As a bond’s maturity approaches, the yield gets closer to the coupon rate. This is because bond owners won’t sell at a large discount since they will soon receive the full face value when the bonds are redeemed.
2. Value of a stock is the present value of ALL its future dividends. The dividends afterwards are also relevant to the investor to know at what price he can sell the shares if he wants to. And to know his total earnings through the stock if he changes his decision to hold stock for more number of years.
3. The price of a stock with constant growing stock grows at the same rate as the dividends because the price of a bond and the dividend are inversely related. If price increases, the yield decreases and the change will be at the same percentage.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.