Bond Analysis

Bond Analysis
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Bond Analysis
A yield is the annual return on an investment. It follows that yield curve could be elucidated as a graph depicting the correlation between bonds and their terms to maturity implying it is an important tool for fixed-income investors. Simply put, a yield curve is a graph of yields to maturity against the term to maturity (for bonds of the same quality and class). This owes to the reality that investors could use the yield curve when pricing bonds, forecasting interest rates, and creating strategies for improving the total returns. It is crucial to highlight that the yield on a bond depends on coupon payments received, and the purchase price for the bond. This paper discusses the yield curve using a graph plotted from data collected from the wall street journal website and explains the effect of different circumstances on the bonds duration measure.
As aforementioned, data on the yields and term to maturity was obtained from baron’s website. A graph of yield to maturity against term to maturity was plotted, which is represented in figure 1 below. The graph begins with a term to maturity of three months and extends to a term to maturity of 30 years. The shape of the yield curve is explained by reasons two main reasons: investors’ expectations of future interest rates and risks premiums that investors require for holding long-term bonds (Choudhry, 2010). It is notable that the author further argues that there are three main theories that could be used to explain the shape of a yield curve. These theories include the liquidity preference theory, the habitat theory, and the pure expectations theory. It follows that all the three theories could be explained the shape of the yield curve below, but we shall focus on the liquidity preference theory.
According to the liquidity preference theory, investors are not only rewarded for their future expectations of interest rates, but also for the risk of investing in bonds for longer periods (Fabozzi, 2012). The graph below indicates an upward trend in the yield of bonds for the next twenty years. It follows that investors believe the interest rates will rise steadily for the next years. It should also be noted that the graph has lower yields for short term to maturity bonds, but the yields increase progressively with an increase in the term to maturity. Simply put, the bonds have higher yields...