Ytm Bond Valuation

2(c) For a comparison of the bond yields, effective YTM should be used instead of the APR, as the APR does not reflect the actual return for the bond. It is the annual multiple of the interest rate and the effect of compounding on a sub-annual or super-annual basis is ignored. It will therefore not be a true measure of the returns on the bond.

2(d) YTM means Yield to Maturity. YTM is calculated by discounting all future cash flows that will be received from holding the bond till maturity. It assumes that all cash flows / coupon payments received from the bond are reinvested at the YTM.

The assumptions used in calculating YTM are as follows:

• All coupons are reinvested at YTM.

• Bond will be held till maturity.

3(a) Price risk is the risk of a decline in the price of a stock or investment in the future due to a decline in the interest rate. It is dependent on factors like the coupon rate of the bond, the years to maturity and the duration of the bond.

3(b) The bond with the 25-years to maturity will have the highest risk as cash flows are discounted over a longer time period. For a bond with higher number of years to maturity, higher amount of cash flows are to be paid at a later date and these cash flows cause the prices to fluctuate more as they are discounted over a longer time period.

3(c) The bond with 25 years to maturity will be affected the most as a longer maturity means higher price sensitivity. Same is supported by the calculations shown in the table below.

...