Will a bond's yield to maturity increase or decrease when bankruptcy happens?

Answer 1

With bonds traded in the open market, it is the accepted rule that when price goes up, yield goes down. This is due to the fact that the terms of the bond do not change once it is issued. If a bond is issued with a 3% coupon, for example, that money is guaranteed for the person who is holding that bond to maturity. So if the price of the bond goes down, the yield will actually go up since you are actually paying less for that same amount of guaranteed money. Keep in mind that current yield is coupon/price. A high yield though is not always a good thing. These bonds that have a high yield as a result of being traded at a very low price are colloquially known as junk bonds, although the industry term for them is "high yield". High yield is obviously a good thing, but the implication is that those bonds carry a very high risk of non-payment. This could be because the issuer is not trustworthy in their ability to repay. Usually high yield bonds come from sources that have poor ratings from Moody's, S&P and Fitch or are not rated at all. Thus it all comes down to risk vs. reward. If one of these high yield bonds actually does pay out on maturity, the holder is a big winner. What is also likely is that the bond issuer defaults on the responsibility and the holder loses.

In the case of a bankruptcy it is always the case that risk increases which will drive down price which, as discussed above, will push yield up.