BOND
YIELD - ECONOMY
News:
Despite rising yields,
Indian G-secs better placed than peers
What's
in the news?
●
The US 10-year treasury yield moving close
to 5 per cent has created an upheaval in financial markets.
●
Indian
10-year g-sec yield has also edged around 25 basis points
higher over the past month. But the pressure on Indian g-secs appears much
lower compared to other assets such as equity.
Bond:
●
A bond is a loan made by an investor to a borrower for a set period of time in
return for regular interest payments.
●
The time from when the bond is issued to
when the borrower has agreed to pay the loan back is called its ‘term to maturity’.
●
The bond issuer uses the money raised from
bonds to undertake various activities such as funding expansion projects,
refinancing existing debt, undertaking welfare activities, etc.
Bond
Yield:
●
It is the return an investor expects to receive each year over its term to
maturity.
●
It partially depends on coupon payments,
which refer to the periodic interest income obtained as a reward for holding
bonds.
●
The bondholders receive the bond’s face
value at the end of the bond’s life. However, one may buy bonds at par value, discount (at a price lower than par
value) or premium (at a price higher
than par value) as they trade in the secondary market.
●
Therefore, the prevailing market price of
bonds also affects the bond yield.
●
It is calculated by using the following
formula, Bond Yield = Coupon Amount/
Price
Bond
Yield and Bond Price Difference:
●
Price and yield are inversely related.
●
As the price of a bond goes up, its yield
goes down and as yield goes up, the price of the bond goes down.
Example:
●
Suppose interest rates fall. New bonds
that are issued will now offer lower interest payments. This makes existing
bonds that were issued before the fall in interest rates more valuable to
investors, because they offer higher interest payments compared to new bonds.
As a result, the price of existing bonds will increase.
●
However, if a bond's price increases it is
now more expensive for a potential new investor to buy. The bond's yield will
then fall because the return an investor expects from purchasing this bond is
now lower.