Bond Value

Key Takeaways

  • All bonds expose investors to

    • default risk (the risk that coupon and principal payments won't be made),
    • reinvestment risk (the risk that coupon payments will be reinvested at lower rates),
    • interest rate risk (the risk that changing interest rates will affect bond values),
    • inflation risk, (the risk that inflation will devalue bond coupons and principal repayment).

  • Bond returns can be measured by yields.

    • The current yield measures short-term return on investment.
    • The yield to maturity measures return on investment until maturity.
    • The holding period yield measures return on investment over the term that the bond is held.

  • There is a direct relationship between interest rates and bond yields.
  • There is an inverse relationship between bond yields and bond prices (market values).
  • There is an inverse relationship between bond prices (market values) and interest rates.
  • The yield curve illustrates the term structure of interest rates, showing yields of bonds with differing maturities and the same default risk. The purpose of a yield curve is to show expectations of future interest rates.

  • The yield curve may be

    • upward sloping, indicating higher future interest rates;
    • flat, indicating similar future interest rates; or
    • downward sloping, indicating lower future interest rates.