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Relationship between bond price and YTM

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1. Describe the relationship that exists between the price of a bond and the bonds yield to maturity (YTM) Why does this relationship exist?

2. Explain the concept of time value of money. How is it applied in finance and why is it so important?

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Solution Summary

The solution explains the relationship between bond prices and YTM and also the concept of time value of money

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1. The yield to maturity (YTM) is the required return by the investor on the bond. It is calculated by discounting the expected cash flows by the required return an dequating these discounted cash flows to the price of the bond. The relationship can be expressed matematically as
Price=Discounted Cash Flows (Interest+Principal) at rate Kd
where Kd is the required return for the investor.
This relationship exists snce an investor is willing to pay an amount or invest an amount in a bond, only if the return on the bond are which are acceptable to the investor. If the price that the investor arrives at, after discounting the cash flows at ...

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