Fixed Income BMC module. When investors doubt the creditworthiness of a borrower, what should happen to the price and yield of the bond?

Question:- Fixed Income BMC module. When investors doubt the creditworthiness of a borrower, what should happen to the price and yield of the bond?

1:- Price goes up, yields go up

2:- Price goes down, yields go up

3:- Price goes down, yields go down

4:- Price stays the same, yields go down

5:- Price goes up, yields go down

Answer:- The correct option is 2. Price goes down, yields go up

Bond yields rise and bond prices wane when investors are in doubt about a borrower’s creditworthiness.

That is because bonds are income securities whose yields and coupon payments remain constant over specific periods. If investors feel the borrower is more likely to default on such payment, then this bond decreases in value and no investor will be prepared to purchase it for a greater price.

However, investors still ask more compensation for the higher assumed risk. This causes the yield on the bond to rise, which trades inversely with price.

Overall, weak credibility of the borrower is one reason bond prices drop and yields increase. It is considered to be more risky so investors buy it at cheaper prices and demand higher interest rates as their compensation (Rational Expressions, Inc, 2023).

So, in this given case the right relationship between price and yield of a bond when its borrower is doubtful from investors point would be that the lower it gets on prices, higher they go up on yields.