Bonds: Bonds are simply defined as a contract between the lender and the borrower.
CHARACTERISTICS OF BOND:
1. FACE VALUE: It is the amount that will be worth at the time of maturity of your bond.
It is also used as a reference amount that is used for determining interest rates.
2. COUPON RATE: It is basically the rate of interest for the bond.
for instance, a coupon rate of 3% means the bondholders will get the 3% of the face value.
3. MATURITY DATE: The date on which the bond will be mature i.e. the bond issuer will pay the face value.
There are various types of bonds such as corporate bonds, municipal corporation bonds, agency-based bonds, and government bonds.
Here, We will talk about what the government bonds depict.
HOW IT IS CALCULATED?
YIELD = ( COUPON RATE *100)/ PRICE
If the bond price remains constant then the yield remains the same as the coupon rate.
But, it keeps on changing and hence we have:
BONDS TRADING AT A PREMIUM: If the price of the bond increases than its face value, it is termed as bonds trading at a premium. And in this case the field of bonds will be lower.
BONDSTRADING AT A DISCOUNT: If the price of bonds decreases than the face value, it is termed as bonds trading at a discount. And the yields will be higher.
BOND PRICE IS INVERSELY PROPORTIONAL TO THE BOND YIELDS
HOW BOND YIELDS INTERACT WITH OTHER KEY ECONOMIC VARIABLES.
1. Interest rate and monetary policy: The current interest rate in the market indirectly determines the rate of return for investment.
FOR INSTANCE, if the interest rate of market is 10% and the bond coupon rate is 5% the investor will not find the bond yields as much attractive and hence, the price of the bond yields decreases.
2. Stock : The govt. bond yields are "risk free", and if the the yields are higher then investors will be more attracted towards the bonds, therefore, the stock markets price will be driven down gradually.
The higher bond yields indirectly increases the cost of borrowing for companies as wee as individuals. Thereby reduces the profit of the shareholders or dividends and also directly affect the budget of retail borrowers.
IMPACT OF US BOND YIELDS ON OTHER COUNTRIES:
1. Flow of investment: US market acts as a source of flow into equity markets to other countries, and, if the yields increases it means the US makes keeping money in domestic bonds lucrative for the country's investors.
2. CURRENCY VALUE: If the flow of capital is reduced it directly depreciates the currency value of that country and vice versa.
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