Exercise

Plotting the price/yield relationship

Although there is an inverse relationship between price and yield, this relationship is not linear. This means that changes in price due to change in yield could differ substantially depending on whether the yield goes up or down. We will revisit this important concept when we discuss the concept of convexity in Chapter Three and how an adjustment is necessary to account for this curved relationship between a bond's price and yield. For now, just keep in mind that this inverse relationship is non-linear.

In this exercise, you will assume that you have a bond with $100 par value, 10% coupon rate, and 20 years to maturity. Note that this is different from the bond you've been working with to this point! Your goal is to value this bond at different levels of yield using your bondprc() function, which is available in your workspace.

Instructions

100 XP
  • Create the vector prc_yld from 2% (0.02) to 40% (0.40) by increments of 1% (0.01) by using the seq() function.
  • Use data.frame() to convert prc_yld to a data frame.
  • Use the pre-written for loop with bondprc() to calculate bond price at different yield levels in prc_yld. Try to understand the behavior of the loop.
  • Your prc_yld object now contains a column for yield (prc_yld) and a column for price (price). Plot this object using the pre-written code to see the relationship between price and yield to maturity (YTM).