Relationships Between the Bond Price and Bond Features

Assume you are considering investing in one of three health care companies' bonds. All three bonds mature in 5 years and have the same credit rating. Based on the information below, which bond would most likely provide an investor the highest total return? | Bond | Coupon | Price | |------------------|------|----------| | Health Dream | 6% | Par | | Wellness Works | 5% | Discount | | Home Health Care | 8% | Premium |

Incorrect. Buying a bond based on coupon payments only addresses one part of total return.

Incorrect. Buying a bond at a discount is only addresses one part of the total return.

After doing further analysis, you decide to consider additional bonds for possible investments. All bonds have a yield-to-maturity of 6%. | Bond | Coupon | Maturity | |------------------|------|----------| | Life Longevity | 2% | 5 years | | Wellness Works | 5% | 5 years | | Health Dream | 6% | 5 years | | Home Health Care | 2% | 7 years | | Healthy Living | 5% | 7 years | Which bond’s price would go down the most if current market interest rates increase 25 bps?

Incorrect. The coupon effect applies to the bond, but there is another effect that needs to be considered.

Incorrect. The Wellness Works bond’s price would go down the least.

Which bond’s price would go up the least if current market interest rates decrease by 50 bps?

Incorrect. The maturity effect applies to the bond, but there is another effect that needs to be considered.

In summary: [[summary]]

Incorrect. The Healthy Living bond’s price would go up the most.

Correct! Bond prices are inversely related to market discount rates. This means that as current market interest rates go up, bond prices will go down. The Health Dream bond is priced at par, which means that the 6% coupon is the market interest rate. The Wellness Works bond is offering a coupon that is below market discount rates. For an investor to buy a bond that offers less cash flow from coupon payments, the bond must be offered at a discount. Since the Home Health Care bond provides a higher coupon than the market interest rate, the bond would be trading at a premium.

Bond prices are inversely related to the movement of current market interest rates. Bond price changes are also impacted by the direction of movement in the market discount rate, the bond's coupon rate, and amount of time left until maturity. The __convexity effect__ reflects a greater percentage price change when the market rate goes down compared to when it goes up for bonds that have the same coupon and maturity date. The __coupon effect__ reveals a greater percentage price change on a lower coupon bond for bonds that have the same maturity date. The __maturity effect__ indicates a greater percentage price change for a longer term bond for bonds with the same coupon rate.

Great job! The Home Health Care bond has the combination of the lowest coupon (coupon effect) and the longest maturity (maturity effect).

Great job! The Health Dream bond has the combination of the shortest maturity and highest coupon.

Holding market discount rates constant, a bond's price will change with the passage of time. Remember that bonds pay par at maturity. Therefore, if a bond is trading at a discount or premium there is a price movement toward par as the bond gets closer to maturity. This price movement to par is referred to as __constant yield-price trajectory__.

Home Health Care because it has the largest coupon

Wellness Works because it is trading at a discount

The bonds would be priced where an investor would be close to indifferent

Life Longevity

Wellness Works

Home Health Care

Wellness Works

Health Dream

Healthy Living

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