Assignment 3

Assume a Face value of Rs. 1000

Coupon rate = 7%

Yield to maturity (YTM) = 3% to 11%

Time to maturity = 1 year to 10 years

Using the formula for the bond price,

Table 1. Values for the Summation Component in the formula

YTM
  3 4 5 6 7 8 9 10 11
1 67.96 67.31 66.67 66.04 65.42 64.81 64.22 63.64 63.06
2 133.94 132.03 130.16 128.34 126.56 124.83 123.14 121.49 119.88
3 198.00 194.26 190.63 187.11 183.70 180.40 177.19 174.08 171.06
Years to Maturity

4 260.20 254.09 248.22 242.56 237.10 231.85 226.78 221.89 217.17

5 320.58 311.63 303.06 294.87 287.01 279.49 272.28 265.36 258.71
6 379.20 366.95 355.30 344.21 333.66 323.60 314.01 304.87 296.14
7 436.12 420.14 405.05 390.77 377.25 364.45 352.31 340.79 329.85
8 491.38 471.29 452.42 434.69 417.99 402.26 387.44 373.44 360.23
9 545.03 520.47 497.55 476.12 456.07 437.28 419.67 403.13 387.59
10 597.11 567.76 540.52 515.21 491.65 469.71 449.24 430.12 412.25

Table 2. Values for the Face Value Component in the formula

YTM
  3 4 5 6 7 8 9 10 11
1 970.87 961.54 952.38 943.40 934.58 925.93 917.43 909.09 900.90
2 942.60 924.56 907.03 890.00 873.44 857.34 841.68 826.45 811.62
Years to Maturity

3 915.14 889.00 863.84 839.62 816.30 793.83 772.18 751.31 731.19

4 888.49 854.80 822.70 792.09 762.90 735.03 708.43 683.01 658.73
5 862.61 821.93 783.53 747.26 712.99 680.58 649.93 620.92 593.45
6 837.48 790.31 746.22 704.96 666.34 630.17 596.27 564.47 534.64
7 813.09 759.92 710.68 665.06 622.75 583.49 547.03 513.16 481.66
8 789.41 730.69 676.84 627.41 582.01 540.27 501.87 466.51 433.93
9 766.42 702.59 644.61 591.90 543.93 500.25 460.43 424.10 390.92
 10 744.09 675.56 613.91 558.39 508.35 463.19 422.41 385.54 352.18

Table 3. Bond Price for a coupon rate of 7% and the face value of Rs. 1000 (summation of Table 1
and Table 2)

YTM
  3 4 5 6 7 8 9 10 11
1 1038.8 1028.8 1019.0 1009.4 1000.0 990.7 981.7 972.7 964.0
2 1076.5 1056.6 1037.2 1018.3 1000.0 982.2 964.8 947.9 931.5
3 1113.1 1083.3 1054.5 1026.7 1000.0 974.2 949.4 925.4 902.3
Years to Maturity

4 1148.7 1108.9 1070.9 1034.7 1000.0 966.9 935.2 904.9 875.9

5 1183.2 1133.6 1086.6 1042.1 1000.0 960.1 922.2 886.3 852.2
6 1216.7 1157.3 1101.5 1049.2 1000.0 953.8 910.3 869.3 830.8
7 1249.2 1180.1 1115.7 1055.8 1000.0 947.9 899.3 853.9 811.5
8 1280.8 1202.0 1129.3 1062.1 1000.0 942.5 889.3 840.0 794.2
9 1311.4 1223.1 1142.2 1068.0 1000.0 937.5 880.1 827.2 778.5
10 1341.2 1243.3 1154.4 1073.6 1000.0 932.9 871.6 815.7 764.4

Varying Theorems from the Table

1. Theorem 1: As interest rates increase, bond prices decrease, and vice versa. Price (value) and
YTM move inversely.

When we look at the table, we can see that the prices of the bonds for each maturity term drop
when the yield to maturity (YTM) rises from 3% to 11%. For instance, the price of a bond with a
maturity of 5 years falls from 1183.2 rupees when the yield to maturity is 3% to 852.2 rupees when
the yield to maturity is 11%. Similarly, the price of a bond with a maturity of 7 years falls from 1249.2
rupees when the yield to maturity is 3% to 811.5 rupees when the yield to maturity is 11%. This is in
agreement with the First Theorem.

2. Theorem 2: For a given interest rate, the bond price change is smaller for longer-term bonds
than for shorter-term bonds.

We can see this by comparing the changes in bond prices for different maturities at a given YTM
changes. For example, consider the change in bond prices for a YTM of 20% for bonds with
maturities of 1styear to 2nd year and for 9th year to 10th years. The bond price for the 1st and 2nd year
decreases from 972.7 to 931.5 rupees, a change of 41.2 rupees. The bond price for 9 th and 10th year
bond decreases from 778.5 to 764.4 rupees, a change of 14.1 rupees. The change in bond price from
the 1st year to 2nd year is much larger than that of the 9 th to 10th year, consistent with Theorem 2.

3. Theorem 3: Price changes are not symmetrical on both sides when YTM is increased or
decreased by 1%. The bond price-yield relationship is convex.
To prove this theorem using the given table, let's take an example of a bond with a coupon payment
of 7%, a face value of 1000 rupees, and a maturity of 5 years.

From the table, we can see that the bond price when YTM is 6% is 1042.1 rupees. If we increase the
YTM by 1%, i.e., to 7%, the bond price decreases to 1000 rupees, a change of 42.1 rupees. However,
if we decrease the YTM by 1%, i.e., to 5%, the bond price increases to 1086.6 rupees, a change of
44.5 rupees.

This shows that when the YTM is increased by 1%, the bond price decreases by a greater amount
than when the YTM is decreased by 1%. Hence, the price changes are not symmetrical on both sides.

This theorem is also known as the concept of convexity in bond price theory, which states that the
price of a bond is not a linear function of its yield. The price-yield relationship is curved, and the
degree of curvature is known as convexity. This means that the price change is not proportional to
the change in yield, and the price-yield curve is steeper on the left-hand side than on the right-hand
side.

4. Theorem 4: Increases or decreases in bond price have diminishing rates as maturity

increases.

The theorem can be proven using the table as follows:

If we look at the changes in bond price for a constant increase in YTM, we can see that as maturity
increases, the rate of change in bond price decreases. For example, consider the change in bond
price when YTM increases from 3% to 4% for each maturity year. We can see that for a maturity of 1
year, the bond price changes from 1038.8 to 1028.8, a change of -1.0%. However, for a maturity of
10 years, the bond price changes from 1341.2 to 1243.3, a change of -7.3%. Thus, we can see that as
maturity increases, the rate of change in bond price decreases.

We can also look at the changes in bond price for a constant increase in maturity. For example,
consider the change in bond price when maturity increases from 1 year to 2 years for each YTM. We
can see that for a YTM of 3%, the bond price changes from 1038.8 to 1076.5, a change of 3.6%.
However, for a YTM of 11%, the bond price changes from 964.0 to 931.5, a change of -3.4%. Thus,
we can see that as YTM increases, the rate of change in bond price decreases.

Overall, the data from the table supports the theorem that "Increases or decreases in bond price
have diminishing rates as maturity increases".

5. Theorem 5: Volatility increases as coupon rate decreases and vice-versa. For a given bond,
the higher the coupon rate, the less its price will vary as interest rates change.

To prove this theorem, we need additional Tables for different coupon rates.

Table 4. Bond Price for a coupon rate of 5% and a face value of Rs. 1000

YTM
  3 4 5 6 7 8 9 10 11
1 1019.4 1009.6 1000.0 990.6 981.3 972.2 963.3 954.5 945.9
Years to

2 1038.3 1018.9 1000.0 981.7 963.8 946.5 929.6 913.2 897.2

3 1056.6 1027.8 1000.0 973.3 947.5 922.7 898.7 875.7 853.4
 4 1074.3 1036.3 1000.0 965.3 932.3 900.6 870.4 841.5 813.9
5 1091.6 1044.5 1000.0 957.9 918.0 880.2 844.4 810.5 778.2
6 1108.3 1052.4 1000.0 950.8 904.7 861.3 820.6 782.2 746.2
Maturity

7 1124.6 1060.0 1000.0 944.2 892.2 843.8 798.7 756.6 717.3

8 1140.4 1067.3 1000.0 937.9 880.6 827.6 778.6 733.3 691.2
9 1155.7 1074.4 1000.0 932.0 869.7 812.6 760.2 712.0 667.8
10 1170.6 1081.1 1000.0 926.4 859.5 798.7 743.3 692.8 646.6

Table 5. Bond Price for a coupon rate of 6% and a face value of Rs. 1000

YTM
  3 4 5 6 7 8 9 10 11
990.
1 1029.1 1019.2 1009.5 1000.0 7 981.5 972.5 963.6 955.0
981.
2 1057.4 1037.7 1018.6 1000.0 9 964.3 947.2 930.6 914.4
973.
3 1084.9 1055.5 1027.2 1000.0 8 948.5 924.1 900.5 877.8
966.
4 1111.5 1072.6 1035.5 1000.0 1 933.8 902.8 873.2 844.9
Years to Maturity

959.
5 1137.4 1089.0 1043.3 1000.0 0 920.1 883.3 848.4 815.2
952.
6 1162.5 1104.8 1050.8 1000.0 3 907.5 865.4 825.8 788.5
946.
7 1186.9 1120.0 1057.9 1000.0 1 895.9 849.0 805.3 764.4
940.
8 1210.6 1134.7 1064.6 1000.0 3 885.1 834.0 786.6 742.7
934.
9 1233.6 1148.7 1071.1 1000.0 8 875.1 820.1 769.6 723.1
929.
10 1255.9 1162.2 1077.2 1000.0 8 865.8 807.5 754.2 705.5

We can see this from the table by noting that for a given maturity and YTM, the bond prices are
higher for bonds with higher coupon rates.

Consider 5%, 6% and 7% coupon rates for a maturity of 5 years

C = 5%, YTM 4% to 5%, Change = 1044.5-1000 = 44.5

C = 6%, YTM 5% to 6%, Change = 1043.3 – 1000 = 43.3

C = 7%, YTM 6% to 7%, Change = 1042.1 – 1000 = 42.1

Thus we can see that as the coupon rate increase, volatility decreases. (The change for coupon rate
of 7% is less than 5%). Overall, the data from the tables support the theorem.

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