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Bond Yield
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Definition: Bond price is the present discounted value of future cash stream generated by a bond. It refers to the sum of the present values of all likely coupon payments plus the present value of the par value at maturity. To calculate the bond price, one has to simply discount the known future cash flows.
Description: The price of a bond and its yield-to-maturity are negatively correlated to each other. When the yield-to-maturity is higher than the coupon rate, the price of a bond is less than the face value and vice-versa. Usually bonds are issued at coupon rates close to the prevailing interest rate, so that they can be sold close to their face values.
However as time passes, bonds frequently trade at prices that are different from their face values. While two parties can agree on a price and execute a trade, a vast majority of bonds are sold either through a public sale or through an exchange platform and the price of the bond is thus determined by the market, and as a result, may vary every minute.
The price of a bond issued by a party is directly linked to the credit rating of that party, since there is always a default risk associated with a bond, which means that the borrower might not be able to pay the full or partial amount of the loan taken. So, bonds with low ratings, called junk bonds, are sold at lower prices and those with higher ratings, called investment-grade bonds, are sold at higher prices.
When interest rates rise, bond prices fall, which results in a rise in yields of the older bonds and brings them into the same category as newer bonds being issued with higher coupons and vice-versa.
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Bond Yield
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