BOND YIELD

BOND YIELD

TOPIC: Economy

Context- On February 1, as Finance Minister indicated that the government would borrow more from the market, the yield on the 10-year benchmark bond issued by the central government jumped 17 basis points to 6.85%.

Concept-

Bond:

• Bond is an instrument to borrow money.
• A bond could be floated/issued by a country’s government or by a company to raise funds.

Bond Yield:

• In simple terms, yield is the amount of return that an investor will realize on a bond. The yield of a bond is the effective rate of return that it earns.
• If the investor holds the bond to maturity, s/he will be guaranteed to get the principal amount back plus the interest.
• However, a bond does not necessarily have to be held to maturity by the investors.
• Instead, investors may sell them for a higher or lower price to other investors.
• The bond prices and yields generally move in opposite directions.
• This is because, as a bond’s price increases, its yield to maturity falls.
• g. for a bond purchased with a par (face) value of $100, and a 10% annual coupon rate, its yield would be 10% (10/100 = 0.10)
• If the bond price fall to $90, the yield would become 11% (10/90 = 0.11).

Factors affecting the yield:

• Monetary policy of the RBI (interest Rates), fiscal position of the government and its borrowing programme, global markets, economy, and inflation.
• A fall in interest rates makes bond prices rise, and bond yields fall.
• Rising interest rates cause bond prices to fall, and bond yields to rise.
• So, a rise in bond yields means interest rates in the monetary system have fallen, and the returns for investors have declined.

Impact of Rise in Bond Yield:

• Stock Market:
  • When bond yields go up, investors start reallocating investments.
  • They shift away from equities into bonds, as they are much safer.
  • Equities become less attractive.
• Borrowing & Economy:
  • When bond yields rise, the RBI has to offer higher cut-off price/yield to investors during auctions.
  • This means borrowing costs will increase.
  • However, RBI is expected to stabilise yields through open market operations and operation twists.
  • Also, government borrowing costs are used as the benchmark for pricing loans to businesses and consumers. So, any increase in yields will be transmitted to the real economy.
• FPI:
  • Traditionally, when bond yields rise in the US, FPIs (foreign portfolio investment) move out of Indian equities. it results in capital outflows from equities and into debt.
  • A higher return on treasury bonds in the US leads investors to move their asset allocation from more risky emerging market equities or debt to the US Treasury.
  • India will likely witness an outflow of funds.
• Banking:
  • A rise in bond yields will put pressure on interest rates in the banking system which will lead to a hike in lending rates.