Bond Price Determinants
Please explain how each affects the bond price. No sources needed.
Solution
Factors Influencing Bond Price
Various factors determine the bond price in any capital markets. This essay shall describe how ten determinants have an effect on the bond price. The first determinant of the bond price is the yield to maturity. The yield to maturity is the return that a bond earns to the investor once the bond matures. The level of yield to maturity is directly proportional to the bond price. This relationship implies that a high yield to maturity will increase the bond price while a low yield to maturity will reduce the bond price.
Second, the cultural, political, and social factors are an important determinant of the bond price. These factors influence the interest rate performance in the economy hence directly affects the bond price in the capital markets. If the cultural, political, and social factors in the economy favor the interest rates, then they will influence the bond price to increase. If these factors do not favor the interest rates in the economy, then they will influence the bond price to decrease. Third, the monetary policy is a determinant of the bond price. The monitory policy in the economy influences the money supply in the economy and interest rates. If the monetary policy favors high-interest rates in the economy, the bond prices will tend to increase, but if they influence the interest rates to reduce, then the bond price will decline.
The inflation in a market is a determinant of the bond price. The inflation makes all the prices in an economy to increase. The high inflation rate in the economy will make the bond price to go up while a low rate of inflation in the economy will influence the bond price to move down. The marketability of a bond price is the fifth determinant that influences the price of the specific bond. If the bond has a high marketability, its demand in the market will be high pushing its price to increase, but if it has low marketability, its prices will be low due to low demand. The taxability of bonds in the market is a determinant of bond prices. If the taxability of a bond is high, its price will tend to be low since the returns of the bond will be subject to high taxes implying low returns. If the taxability of a bond is low, then the bond returns will be high since it will not be subjected to high returns. In such a situation, the bond prices will tend to be high. The Bond option that a bond carries is the seventh determinant of the bond price. Bonds that have an option such as a call option have higher prices than bonds that do not have options. This trend is due to the flexibility and advantages that the options carry such as converting the bond before its maturity.
The systematic risk is a vital determinant of the bond prices. The systematic risk is the market risk that is exposed to bonds in the market. A high systematic risk will cause the bond price to be low due to the uncertainty attached to it while a low systematic risk will cause the bond price to be high. The default risk is the risk that the bond will not earn a return at its maturity date. A high default risk will influence the bond price to be low while a low risk will influence the price to be high. Lastly, the duration that a bond takes to mature will influence its price. Bonds that have a short duration will have higher prices since they are exposed to low-interest risk than bonds that have higher duration before maturity.