Please help to explain: 1- what is the relation between the current yield, ytm and bond price. 2-what is the difference between the total rate of return on a bond and it’s ytm. 3-what happens to ytm if either tie, debt-equity, quick ratios increase.
For normal bonds, as YTM increases, bond price decreases, and vice-versa. (There are some bonds (e.g., interest-only strips in CMOs) for which, in some ranges, if YTM increases, the bond price _ increases _. These are not normal bonds, however.)
For a bond with a fixed coupon, as the price increases, the current yield decreases, and vice versa.
The YTM is the discount rate you apply to future cash flows to discount them to today to get today’s price. This is calculated ex ante (before the fact).
The total return is the total amount the bond investment earns, including price change, coupons, and reinvestment income. This is calculated ex post (after the fact). It’s unlikely that the total return will equal the YTM.
All of these will affect the market’s assessment of the risk of investing in the company’s bonds, which will result in a change to the required rate of return (YTM):
- If TIE increases, that should decrease the risk, so the YTM should decrease.
- If debt/equity increases, that should increase the risk, so the YTM should increase.
- If the quick ratio increases, that should decrease the risk, so the YTM should decrease.
Thank you .
My pleasure.