Question 1

Why do bond prices fall when interest rates rise?

Accepted Answer

When new bonds offer higher yields, existing lower-coupon bonds become less attractive. Their prices must drop until their yield-to-maturity matches the new higher rates. Think of it as competition - investors won't pay full price for 4% when they can get 5% elsewhere.

Question 2

What's the difference between clean and dirty price?

Accepted Answer

Clean price excludes accrued interest - it's the quoted price. Dirty price includes accrued interest since the last coupon - it's what you actually pay. Settlement is at dirty price. Clean price allows easier comparison between bonds at different points in their coupon cycles.

Question 3

Why do longer-term bonds have more price volatility?

Accepted Answer

Longer-term bonds have cash flows further in the future. These distant cash flows are more sensitive to discount rate changes (present value of $1,000 in 30 years changes more with rate moves than $1,000 in 2 years). This is reflected in higher duration.

Question 4

Does a bond's price always converge to par at maturity?

Accepted Answer

Yes, assuming no default. As maturity approaches, the present value of the face value approaches par. A premium bond declines toward par; a discount bond rises toward par. At maturity, you receive par regardless of what you paid. This is called 'pull to par.'

Question 5

How do credit spreads affect bond prices?

Accepted Answer

Credit spread is extra yield over risk-free rates for credit risk. Wider spreads (higher perceived risk) mean higher required yields and lower prices. Narrower spreads mean lower yields and higher prices. Corporate bonds price at Treasury yield + credit spread.

Question 6

Can a bond ever trade above its theoretical price?

Accepted Answer

Briefly, due to supply/demand imbalances, but arbitrage typically corrects this. However, callable bonds have price ceilings near call price since issuers can redeem them. Bonds with special features (tax advantages, liquidity) may trade at premiums to theoretical fair value.

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