Chapter 4 of 6
Bond yields, duration and the yield curve
Connect fixed cash flows, discount rates, duration and the information—and ambiguity—in a yield curve.
In this chapter
Yield is inferred from price and cash flows #
For a plain fixed-income claim, valuation discounts expected payments. With fixed contractual cash flows and other assumptions unchanged, a higher required yield produces a lower price. Credit and liquidity changes can move prices independently of the risk-free rate.
Coupon rate describes the contract’s payment rate relative to face value. Yield describes a return relationship implied by price and stated assumptions. A high coupon does not automatically mean a cheap or low-risk bond.
Duration is a local sensitivity #
Modified duration approximates the percentage price change for a small yield move: price change ≈ −duration × yield change in decimal form. Convexity and other effects matter for larger changes. Duration is not simply the bond’s maturity date.
Different cash-flow timing, coupon structure and embedded options can change sensitivity. A floating-rate claim or callable bond should not be modeled using an unqualified fixed-rate example.
The curve can reflect several forces #
A yield curve relates yields to maturity for a comparable class of instruments. Expected future short rates, term premiums, supply–demand conditions and liquidity can all influence its slope. A curve shape is not a guaranteed countdown to a particular event.
Separate government rates from corporate credit spreads and compare consistent conventions. For macro learning, ask which component changed rather than reading every rise in a corporate yield as a pure central-bank effect.
Decision lab: Duration is a local sensitivity #
A hypothetical modified duration of 5 with a yield rise of 0.50 percentage point implies about −2.5% first-order price change, before convexity and other effects. That does not guarantee the bond’s credit spread stays fixed or its liquidation price matches the model.
Stress a parallel yield move and a nonparallel curve move separately. Identify cash-flow dates, yield convention, credit exposure and liquidity. A long-duration asset’s sensitivity is not equivalent to a forecast that rates will move in the direction you prefer.
Hypothetical worked example
One percentage point is 0.01 in the formula
A hypothetical bond has modified duration 5. If its required yield rises by 0.50 percentage points, the local duration estimate is −5 × 0.005 = −2.5%.
A price of 100 would become approximately 97.5 before convexity and other effects. If someone enters 0.50 instead of 0.005, the estimate becomes wildly wrong.
The approximation does not include a credit event or changes in an embedded option. It is a controlled sensitivity exercise, not a promise that an actual bond can be sold at the calculated value.
Common mistakes
- Confusing percentage points with percentages in sensitivity formulas.
- Treating the yield-curve slope as an infallible forecast.
With duration 5 and a 0.5 percentage-point yield rise, the approximate price change is what?
Make this chapter useful
Can you defend the reasoning?
Before moving on, answer the self-check in your own words and write why each alternative fails. Use the worked example to test that explanation. Then apply it in the module research task; keep the assumptions and the evidence that could change your answer.
Sources and further reading
- Reserve Bank of India: official publications and monetary policy ↗
- Ministry of Statistics and Programme Implementation ↗
- Union Budget: official documents ↗
- NISM: Research Analyst learning topics (scope reference; independent lessons) ↗
Further-reading references from the curriculum source list. Contract sizes, expiry calendars, settlement references, margin parameters and tax treatment can change; verify the current operative documents for the actual product. Worked figures are illustrative, not current quotes.
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