- February 23, 2021
- Posted by: OptimizeIAS Team
- Category: DPN Topics
Context: The rise in bond yields across the world has disrupted the bull rally on the stock markets with the benchmark Sensex of the BSE plunging 1,145 points, or 2.25 per cent
- The rise in bond yields in India is in response to factors such as absorption of additional borrowing by the government, expectation of better growth in the economy and slippage in fiscal deficit.
About Bond Yield
- It is a return an investor realizes on that bond. It is generally a function of the bond’s market price and its coupon or interest payments.
- yield = coupon amount/price. When the price changes, so does the yield.
Understanding bond yield:
- In normal case: If a bond is bought at its $1,000 par value with a 10% coupon. If we hold on to it, the issuer pays $100 a year for 10 years, and then pays back the $1,000 on the scheduled date. The yield is therefore 10% ($100/$1000).
- If sold to the market: Bond prices change on a daily basis of prevailing interest rates (When interest rates are low, bond prices increase and yield decreases) because investors are seeking a better return. If the price of the bond in the market is $800, it’s selling under face value or at a discount. If the price of the bond in the market is $1,200, it’s selling above face value, or at a premium.
- Regardless of the market price of a bond, the coupon remains the same. However, the bond holder continues to receive $100 a year.
- What changes is the bond yield. Selling it for $800, the yield will be 12.5% ($100/$800). If sold for $1,200, the yield will be 8.33% ($100/$1,200).