Relationship Between Bonds and Bond Yield

Table of Contents

Context: Recently, the yield on the 10-year government bond rose sharply by 9 basis points, marking the largest increase in eight months.

What are Bonds and Bond Yields?

Bond: A bond serves as a method for raising capital and can be issued by either a corporation or a government entity.
- Investors may acquire bonds at a value greater than the nominal amount, known as a premium, or below it, which is referred to as a discount.
Bond Yield: The yield on a bond reflects the earnings that an investor receives from the investment.
- When investors purchase bonds, they are essentially extending a loan to the issuer, who in return agrees to provide periodic interest payments and return the principal amount of the bond at maturity.
- The yield encompasses the income generated both from the interest collected and any gains from selling the bond.
- Notably, bond prices and their yields move in opposite directions.

There is an inverse connection between bond values and their yields; as the price of bonds increases, the yield decreases.
Since bonds typically pay a fixed rate of interest, investors tend to offload bonds in anticipation of rising interest rates and conversely, they may acquire bonds when they predict a decrease in interest rates, causing bond prices to escalate.

An uptick in bond yields suggests a market expectation of higher interest rates, prompting investors to divest from current bonds to mitigate potential losses in principal value.
The net asset values (NAVs) of debt funds, which include government securities, tend to drop in response to bond price depreciation triggered by escalating yields.
The pricing of corporate bonds, which are typically more expensive than government bonds, also experiences a downturn due to the overall fall in bond prices.
Debt market participants experience losses as surging yields contribute to the depreciation of bond values and the NAVs of debt-oriented funds.
Equity investors may feel the pinch of rising bond yields since they can lead to increased borrowing costs for businesses, which might in turn impact their profitability.

Understanding Yield Curve Inversion

The yield curve is a graph that plots the yields of bonds with similar credit quality across different maturities.
When short-term bonds yield more than their long-term counterparts, the yield curve is said to be inverted.
Such an inversion in the yield curve is unusual and may indicate a looming economic downturn, affecting both consumers and investors.