If for example, like shown in the table above, the secondary market yield level for a bond with a duration of 5 years (column 5) increases by 0.5 percentage points (row 5), the market price of this bond will decrease by about 2.5% (difference between the new market price of about 97.5 vs. the original price of 100%).
Typical reasons why the secondary market yield level should increase are for example an improvement of the economic outlook, the expectation that key interest rates will be increased in the near future by the central bank or even the fact that the central bank is actually increasing key interest rates.
The secondary market yield level for a specific bond type can also increase, if the market’s risk assessment for this specific type of bond (for example Greek government bonds with a duration of about 5 years) deteriorates. In this case, the market will demand a higher yield to compensate for the higher risk it feels these papers entail. The secondary market yield level will increase accordingly as the market price of current bonds drops. Here, the same sensitivity numbers as presented in the previous table apply.Sensitivity Analysis Credit
The prices of credit instruments (corporate bonds, bank bonds, covered bonds and similar credit instruments) are subject to certain price fluctuations during maturity until repayment.
Prices of credit instruments are subject to similar laws as risk-free (government) bonds, however the (higher) credit risk (i.e. the risk that an issuer cannot fulfil its obligations towards creditors) has a greater influence on the price determination mechanism, and all the more so, the weaker the credit rating or the higher the risk premium. The extent of the credit risk is (in technical terms) a function of 1) the likelihood that an issuer will be unable to meet its obligations (= probability of default) and 2) the monetary loss in the event of such default (= 100% minus the recovery rate).
The following example shows the probability of default (PD) for a credit instrument (here with a five-year maturity and an assumed recovery rate of 40%), depending on the amount of the risk premium. If the probability of default rises, market participants also require a higher risk premium to compensate for the increased risk, and vice versa.
Cumulated 5 j default probability