In this note, we cover how bond prices change as yields change. Students are shown that the price of a bond is a function of its promised payments and the prevailing required rate of return by investors: the bond’s yield. Since the promised payments are generally fixed, changes in the price of a bond relate to changes in its yield. The note introduces the most common measures of interest-rate risk (the sensitivity of bond prices to changes in yield), the Macauley duration and modified duration, and it guides students through calculating their value for two bonds issued by Amazon.com.
At the Darden School of Business, this technical note is taught in the first-year “Valuation in Financial Markets” class; it would also be suitable in a module covering bond pricing and interest rates within the first-year core finance course of an MBA program, or to introduce the pricing of bonds in an investment course.
