Based on the quality of bonds AAA to D, what happens to the price of bonds. Also, how does the duration of maturity change the price.

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justaguide eNotes educator| Certified Educator

Bonds are rated by several credit rating agencies including S&P, Moody's, etc. which have different ways of denoting the quality of the bonds. Bonds with a AAA rating are more secure than those with a D rating. Bonds are rated based on the present assets and liabilities of the issuer, the future cash flows and the resulting financial situation it would be in in the future as predicted by the rating agency.

Issuers of bonds with a higher rating have a higher level of certainty of making interest payments and repaying the principle when the bond matures. As an illustration it is almost certain that the issuer of a bond with a AAA rating is not going to default on any future payments; on the other hand the issuer of a bond with a D rating is in a very bad financial position and is very likely to default.

The buyer of a D-rated bond is taking a much higher risk than a buyer of a bond with a AAA rating. In return for the higher risk being taken the buyer expects a higher rate of return from the bond. This does not change the face value of the bond, instead it changes the price at which the bond is traded in the market. If the credit rating of the issuer falls, the price of the bonds issued by it also decreases.

The difference in the price at which a bond trades based on the duration of maturity is dependent on many factors including the future financial condition of the issuer, the change in the prevailing rate of interest and the alike. In most cases if there is no expected change in the prevailing rate of interest a longer tenure bond would trade at a lower price as the buyer has to accommodate for risk taken over an extended duration of time.