Why is the bond market so sensitive to interest rates? What is the mathematics b

Question

Why is the bond market so sensitive to interest rates? What is the mathematics behind this relationship? Do a Google search to find a corporate bond issue where the company has either defaulted on the payments or called back the bonds. Post your response to above-mentioned questions. What was the reason(s) for the company to either default on payments or call back the bonds? How would you compare the investment in bonds vs. stocks? Which one would you prefer? Is it a good strategy to have a combination of stocks and bonds in your portfolio?

How is it an incomplete question?

Explanation / Answer

Why is the bond market so sensitive to interest rates?

Bond markets are senstive to interest rates because bond price is inversely related with interest rates. A higher interest rate in market means the new bonds that will be issued will provide investors with higher coupon payments than the current ones which investors are holding. So, investors will buy current bonds and sell previous ones due to higher coupon payments owing to higher current interest rates. This demand for higher coupon rate bonds lead to decrease in value of the previous bonds hence the inverse relationship.

What is the mathematics behind this relationship?

Interest rates and bond prices or bond value have inverse relationship i.e. when interest rates go up prices of existing bonds go down and vice versa.

Do a Google search to find a corporate bond issue where the company has either defaulted on the payments or called back the bonds.

Recently Defaulted: Haikou Meilan International Airport Co. Ltd recently defaukted in China and so did Dadong Port Group Co Ltd

Post your response to above-mentioned questions.

What was the reason(s) for the company to either default on payments or call back the bonds?

Reason for default on payments: Bankruptcy / insolvency, liquidity mismanagement etc. In short the bond issuer fails to make scheduled interest or principal repayment within a specified period.

Reasons for recalling: Lower interest rates prevailing currently in the markets so new issues will reduce the interest out go. These bons usually have a callable option embedded

How would you compare the investment in bonds vs. stocks?

You can bifurcate these asset classes based on risk and return expectations. Bonds have lower risk and lower return compared to equity as an asset class.

Which one would you prefer? Is it a good strategy to have a combination of stocks and bonds in your portfolio?

Depends on the investors risk appetite and return expectations. Conservative investor will have a portfolio skewed towards bonds whereas on the opposite spectrum an aggressive investor will have a portfolio skewed towards equity.

Combination of equity and stock in general brings more stability to returns by reducing the volatility or the standard deviation / variance / beta of the portfolio.

How is it an incomplete question?

Because it will vary based on investor risk and return objectives, his preferences and the investment horizon.

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The answers to these questions can go on and on. I have tried to be as brief and lucid as possible. Hope it helps.

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