a coursework

1. These tables above present trends in the price volatility and yield volatility of bonds. As is
shown, bonds with longer maturity will experience an increasing proportion of price changes, a
greater average price changes as well as, the larger standard deviation of the monthly price
changes. In term of yield changes, the long term bonds witness a decrease in monthly percentage
yield changes as well as average value of price changes, a low figure of standard deviation. The
results above are consistent with Liquidity Preference Theory and study of Edwin, E., Martin, G.,
Stephen, B. & William, G (2008). This trend can be explained by risks associated with long term
maturity such as inflation risks, higher market risks..
However, price bonds held until the redemption date are less likely affected by inflation rate.
In addition, as long term - interest rates remain relatively stable with the economic output,
whereas short- term interest respond quickly to alteration of the economy, such as changes in
government policy, status of domestic and global fiscal markets, the changes in future economic
development prospects and inflation. As a consequence, results in the yield volatility and the
standard deviation of the monthly yield changes remain relatively stable
The reason why price of bond with longer term maturity is more volatile than the shorter one
can be explained by measuring the risk involved during the period of time when the bond is buy
to maturity date.
On the other hand, interest rates are unlikely to change significantly in the short term or if it
happens, interest rate also has limited effect on bond price. However, interest rate of short
term securities is more volatile than the longer one. The reason is short term interest rate
change frequently in response to several factors that almost vary continuously such as inflation,
credit supply and demand. In addition, interest rate and bond yield has a proportional relation,
bond yield go up when interest rate increases. This can explain why the yield volatility of short
term government bond is not as stable as the longer one. (Edwin, E., Martin, G., Stephen, B. &
William, G., 2008)

2. According to Liquidity Preference Theory, bond prices in long term tend to be more volatile than in
short term. This point can be clarified by analysing the relativity between duration and bond price
sensitivity: the longer maturity gives the greater duration and the greater the duration the more
sensitive the price, the higher is its market risks. In long term, there are more uncertainties in
comparison with short term, meaning that the long – term investments are riskier. For instance, if an
investor wants to sell his long – term bonds before maturity, he may have to face a significant
discounted market price. However, this risk is not as serious with short maturity bonds because of
the temporary steady tendency of interest rates in short period. On the other hand, short – term
bonds are easier to hold until maturity and investors do not need to concern too much about the
changes in bonds’ prices caused by interest rate effect. That is the reason why price changes tend
to be more significant when maturities increase and give rises to the greater standard deviation.
Meanwhile, yields and interest rates are proportional. The changes in interest rates reflect the
economic events. They respond to every small alteration of the economy, such as changes in
government policy, status of domestic and global fiscal markets, the changes in future economic
development prospects and inflation. Nevertheless, those economic circumstance are irregular while
there is a more customary variability of investment rates resulted from the business cycle, the
fluctuation of credit supply – demand, the developments and constrictions that the economy
encounters over time. More specifically, short – term interest rates increase in developments and go
down in recessions. Long – term interest rates seem not to co – differ much with the economic
output. It could be said that short – term interest rates are more volatile than long – term ones and
due to the relationship between yields and interest rates, we can conclude that the longer the
maturity is, the smaller standard deviation of the monthly yield changes become.
Given the fixed character of the cash flows, yields can only vary as a result of changes in market
prices. Yields variation therefore exposes investors in bonds to uncertainty regarding the market
values of their investments; they have an exposure to market risk. Longer term bond prices
generally are more volatile than bonds with short term maturities. Their prices are subject to
greater uncertainty. In effect, market risk is greater the longer the term to maturity. For this
reason, longer term bonds tend to offer higher yields; the additional element being compensation
for the greater exposure to market risk. The significance of market risk for individual investors
depends on whether they intend to trade the bonds or hold them to maturity. If the intention is to
trade, market risk is an important consideration because it means that traders are exposed to the
possibility of capital loss. On the other hand, there is also the possibility of significant capital
gains in the event of yields falling. For investors intending to hold bonds to maturity market risk
is less of an issue because investors receive all of the remaining coupon payments and the
redemption payment. What happens to the market price in the interim is less important