Bond price vs. Yield buyer, attractive, relation, because

atate2007

What's the plain logic behind the inverse relationship between the bond price and the yield?

Say if the call option increases the price of a bond because it's more attractive for a bond buyer due to the safety the option offers, the the graphical inverse relation states that the yield will hence go down. But why does the yield have to go down in a first place?

If there is a high priced bond that yield low and the other cheaper bond that pays higher yield, shouldn't I be better off with the lower priced bond because I get compensated by the higher streams of profit the yield bring?

After all, in the end you are being refunded back for the same bond price that came out of your pocket from the start. So why not pay cheap and get more out of a bond?

Or if you say the higher priced bond pays higher priced coupons stream relative to the cheaper priced bond, aren't the lump sum rewards be the same in the end?

your help is appreciated.

Bluetick1010

The call option decreases the bond price because the bond issuer has the option to buy the bond back.

The yield doesn't have to change. You can have two bonds. Bond A is callable at 110 and sells for 90 with yield of 8%. Bond B is not callable and selling for 95 with yield of 8%.

> Say if the call option increases the price of a
> bond because it's more attractive for a bond buyer
> due to the safety the option offers, the the
> graphical inverse relation states that the yield
> will hence go down. But why does the yield have to
> go down in a first place?
>
> If there is a high priced bond that yield low and
> the other cheaper bond that pays higher yield,
> shouldn't I be better off with the lower priced
> bond because I get compensated by the higher
> streams of profit the yield bring?

It can work out to be even. Paying more and getting less should be similar to paying less and getting more.

In the case of the callable bond, both bonds give the same amount, but the callable bond costs less up front because of the risk.

JGovender

The call option decreases the bond price wheareas the the put option increases the bond price.

Consider a Treasury bond with the same intrest rate but doest not have a call option.Hence the treasury bond will emerge as the favourate amoung the two bonds as it doest not have any risk involved with it compared to the risk involved when a bond is called. (If a bond is called by the issuer the invester tends to loose the yield over the bond after it is called back.)

To compensate for the risk involved in the call option the price of the bond is DECREASED.
If the price of the bond is decreased say form 100 to 90 the EFFECTIVE % of yield increases as the invester has to pay less amount for a comparitively larger intrest rate.

NOTE: The new owner of the bond will be getting the yield of 8% same as that was offered by the issuer but now he is getting the yield on a relatively lower bond price. This denotes that the yield has incresed.

The yield is always with respect to the market conditions.

Micholien

Consider a case when the company has issued a bond with a call option at 8% yield.

Now when the bonds are callable and the market yield has decreased to 6%, the company can very well call the 8% bonds and in turn raise the funds needed by issuing new bonds with yield of 6%. Thus the callable bonds provides a huge advantage to the issuing company as it has to pay just 6% instead of 8%.

The company calls the bonds only when the market yield decreases and hence the call option has no effect whatsoever if there is an increase in the market yield.

MythosHF

***Study section 16, LOS 64c - Bond values are inversely related

Market rate decreases below coupon rate -> bond price increases

Market interest rate increases about coupon rate -> bond price decreases

***When calculating the price of a bond, the lower the market interest rate, the greater the present value. The price of a bond is the sum of the quotients of the payment stream... ...so the payment stream will be larger with a lower interest rate.