Indicate whether each of the following actions will increase or decrease a bond's yield to maturity:
a. The bond's price increases.
b. The bond is downgraded by the rating agencies.
c. A change in the bankruptcy code makes it more difficult for bondholders to receive payments in the event the firm declares bankruptcy.
d. The economy seems to be shifting from a boom to a recession. Discuss the effects of the firm's credit strength.
e. Investors learn that the bonds are subordinated to another debt issue.
a. The bond's price increases: Because the bond coupon is fixed when the bond is issued, if the bond's price increases investors are paying more to get the same return. (This will generally happen because (a) general interest rates have declined, (b) inflation is expected to be lower in the future, (c) the company's credit strength has increased, (d) the bond is more liquid, and/or (e) the time to maturity has decreased.) Thus, the ...
This solution discusses the effect of various actions on a bond's yield to maturity, and why each action has the stated effect.