Briefly explain factors determines the price of a bond on the secondary market
The price of a bond on the secondary market is determined by several factors including current interest rates, the bond's coupon rate, the bond's remaining maturity period, and the bond issuer's credit rating.
- Interest rates: The prevailing interest rates in the market have an inverse relationship with bond prices. When interest rates rise, newly issued bonds offer higher coupon rates, making older bonds with lower coupon rates less attractive. Consequently, the price of existing bonds on the secondary market may decrease.
- Coupon rate: The coupon rate of a bond is the fixed interest rate paid to bondholders. If the coupon rate is higher than the prevailing market interest rates, the bond's price tends to increase. Conversely, if the coupon rate is lower than the market interest rates, the bond's price may decrease.
- Remaining maturity period: The remaining time until the bond matures also affects its price. Bonds with shorter maturities generally have less price volatility and are less sensitive to interest rate changes. In contrast, bonds with longer maturities are more sensitive to interest rate fluctuations.
- Credit rating: The credit rating of the bond issuer, as determined by rating agencies, influences bond prices. Bonds issued by entities with higher credit ratings are considered less risky and tend to have higher prices. Conversely, bonds issued by entities with lower credit ratings may have lower prices due to their higher perceived risk.
Other factors that may impact bond prices include market demand and supply dynamics, overall market conditions, inflation expectations, and changes in the issuer's financial health.